聯合太平洋集團 (UNP) 2010 Q3 法說會逐字稿

Greetings and welcome to the Union Pacific third quarter 2010 earnings.

(Operator Instructions) As a reminder this conference is being recorded and the slides for today's presentation are available on Union Pacific's website.

It's now my pleasure to introduce your host, Mr.

Jim Young, Chairman and CEO for Union Pacific.

Thank you Mr.

Young.

You may now begin.

Good morning, everyone.

Welcome to Union Pacific's third quarter conference call.

With me today are Jack Koraleski, Executive Vice-President of Marketing and Sales, Rob Knight our CFO and joining us for the first time is Lance Fritz, our newly appointed Executive Vice-President of Operations.

As you know, Dennis Duffy our head of operations since 1998 retired this month.

Dennis was great asset to the UP team helping to transform our rail operations and we wish him the best.

As for the third quarter we are reporting record results.

Starting with the earnings of $1.56 per share.

That's a 54% increase versus the third quarter of 2009 and our most profitable quarter ever.

Third quarter operating income was a record $1.4 billion, a 46% increase.

Similar to last quarter, we achieved volume growth across each of our six business teams.

Total third quarter car loadings were up about 14% to more than $2.3 million.

That's our highest level in two years but still 9% below our peak in 2007.

As business levels on the Union Pacific continue to grow, we are providing excellent service to our customers as recognized by a new best in quarterly customer satisfaction.

We are utilizing processes, technology and commitment to excellence to safely and efficiently deliver the service product customers expect from Union Pacific.

We combine strong volume growth, pricing gains and great operating efficiency to produce a record operating ratio of 68.2%.

This is 5.6 points better than last year's record performance and our second consecutive quarter under 70%.

It's very rewarding to report another record performance on behalf of Union Pacific who provide great service to our customers every day.

As business levels increase on our railroad we are leveraging our capital investments and delivering on the customer commitments and potential of the UP franchise.

With that, let me turn it over to Jack to walk through the performance of our business.

Jack.

Thank you Jim and good morning.

With excellent service and an improved economy, our third quarter volume increased 14% as all six businesses again posted gains.

Our core price came in at about 5.5% with improvement in each of the six groups.

Those price gains combined with boost from increased fuel surcharge revenue and offset by some negative mix produced a 6% increase in average revenue per car overall.

Stronger volume and improved revenue per car drove freight revenue up 21% for the quarter pushing us up over $4 billion mark for the first time since fourth quarter of 2008.

The strength of our value proposition was reflected in our customer satisfaction scores where we set a new best ever quarterly mark of 90.

Satisfaction improved as we moved through the quarter even as volume grew heading into peak season.

In September we scored a 91 setting our new best ever month.

So with that let me walk you through the performance in each of our six businesses.

Ag products revenue grew 16% as 7% volume growth combined with an 8% increase in average revenue per car.

Strong worldwide demand for US wheat, corn and soy beans drove a 47% increase in whole grain exports.

That strong pull led to a slight reduction in our domestic shipments

Ethanol continues to be the most significant driver of growth in our grain product segment with volume up 1500 cars or about 9%.

Growth in DDG's also continued with volume up 4% and gluten meal shipments were up 23%.

Last but not least strong US demand for Mexican beer led to a 22% increase in import beer volumes.

Our automotive revenue grew 36% as an 18% increase in volume combine with 16% improvement in average revenue per car which reflects some of the contracts that we repriced over the recent past.

Volume gains were the result of a 32% increase since finished vehicle shipments as production levels in 2010 continued to closely match vehicle sales.

With around 50% of our finished autos and parts business moving to and from Mexico, the flooding in Mexico and south Texas in the aftermath of hurricane Alex resulted in supply chain disruptions that led to flat volume in our vehicles parts business.

Our chemicals volume grew 9% which combine with a 5% improvement in average revenue per car produced a 14% increase in revenue.

Fertilizer volume was up 26% largely on the strength of export Potash.

Continued strong demand for finished lubricants and fuels produced an 18% increase in petroleum shipments.

The start up of unit train service as well as incremental manifest business to unloading terminals at St.

James Louisiana drove an 80% increase volume in the emerging crude oil segment of this market.

Plastics car loadings were up 7% with growth and domestic shipments and movement to storage and transit more than offsetting declines in export volumes.

Industrial chemical shipment grew 5% boosted by increased industrial production and return to more normal inventory levels.

Turning to coal, our energy revenue was up 11% as volume grew 1% and average revenue per car increased 10%.

The fourth hottest summer on record and increased demand for electricity that comes with a stronger economy drove 4% growth in southern Powder River Basin tonnage.

By the end of August the SPRB stockpiles were slightly below normal levels having to climb to an estimated 53 days of burned down from 75 days at the same time last year.

Unfortunately the demand for Colorado Utah coal continued to be weak contributing to a 12% decline in volume.

Coal stockpiles remain above normal in this market which faces strong competition not only from eastern coal sources but is also from natural gas conversions in the east.

Additionally production downtime associated with relocating mining equipment to other reserves reduced coal supply and will most likely continue into 2011.

Industrial products revenues grew 25% as a 20% increase in volume combined with a 4% improvement in average revenue per car.

With a stronger auto industry and increased drilling activity driving demand for steel, our steel and scrap car loadings grew 44%.

Nonmetallic mineral shipments were up 38% with that increased drilling activity also translates into demand for frac sand, barites and bentonite.

Hazardous waste shipments were up 101% driven by year-over-year growth of uranium tailings for the Department of Energy.

Despite solid profitability and the high volume low revenue per car short haul movement has significant negative mix effect on overall industrial products where average revenue per car would have actually been 8% if we excluded impact of the uranium tail in smooth.

Last but not least while there is little improvement in construction related markets are rock shipments were up 20% supported by drilling related construction.

Our lumber and cement shipments were actually down year-over-year.

A 24% increase in intermodal volume combined with an 8% improvement in average revenue per unit to drive intermodal revenues up 34%.

International intermodal volume grew 30% as improved consumer demand and inventory replenishment led to a peak season and we also benefited from share gains by our largest ocean carrier.

Excellent service that's competitive with single driver truck and major lanes continues to attract highway conversion driving a 16% growth in our domestic intermodal segment.

Our Streamline subsidiaries door to door product grew 70% with half of that growth coming off the highway.

For our international segment average revenue per unit was up 4% with price gains and fuel recovery partially offset by a combination of negative mix as more revenue empties moved back to the west coast to address the shortage of boxes in Asia and our last remaining international intermodal legacy contract continued to grow.

A 17% improvement in average revenue per unit for domestic intermodal shipments reflects improved price performance and better fuel surcharge recovery made possible by the illumination by our legacy contracts as well as the new product offerings in both our EMP and UMAX box programs.

As we look to the rest of the year, diversity of our business is again emerging as a strength.

We should continue to see volume growth even some markets are struggling to show signs of recovery with no indication of any dramatic change up or down in the economy our run rate should hold until we see the normal softening as peak season winds down when the end of the year approaches.

Tight truck supply will create opportunities not only in intermodal but for our car load business as well and strong value proposition built on great service will put us in good service to capitalize on opportunities across all six businesses.

Core price improvement will combine with volume gains to drive our revenue growth.

Let me give you a quick overview of some the specific growth drivers that we expect to see in the fourth quarter.

Our industrial products business look to have the most upside with the best opportunities in markets that are benefiting from improved product production, increasing drilling activity and hazardous waste disposal.

International and domestic intermodal segments will continue to drive growth with some indication that the international peak may be slightly longer than we thought.

Fall demand for fertilizer is expected to be stronger than last year and petroleum should post gains with crude -- growth of crude oil shipments to St.

James and increased residual fuel oil moves.

Also looks like industrial chemicals and soda ash will hold their current run rates and that will close the rate stronger than a year ago.

Increased electrical demand and expectation of inventory replenishment following a hot summer are expected to keep our coal trains moving and while feed grain exports will likely not be able to match last year's near record levels, wheat exports should supply a nice boost to our ag products business as we close the year and move into next.

Finally we expect our automotive run rate to hold -- our automotive run rate to hold steady but sales forecast to stay in the mid-$11 million range through the end of the year with production slightly ahead of the fourth quarter of last year.

That's how we see the quarter shaping up and with that I will turn it over to Lance for his report on operation.

Lance.

Thank you, Jack and good morning.

Let me start today with safety which is where our operating teams starts every day.

For the month of September the employee reportable injury rate is 1.36.

A 6% improvement versus last year.

With safety we focus on continuous improvement toward the ultimate goal of zero incidents we emphasize severity to lessen the impact both to the employee and the Company.

In addition to the human and financial benefits running a safe operation enhances service and productivity.

Training is especially important today in the on boarding process as we bring employees back from furlough who haven't worked for us for a year or more.

And as our hiring efforts increase, our ability to put new employees into train service with a safety mind set is crucial.

Turning to service, our service score card for the quarter is illustrated on slide 15.

As car loads grew almost 5% July to September our service delivery index remained near record levels and velocity increased through the quarter.

By applying the principals of the unified plan and utilizing available resources we absorb the increased work load on the network while maintaining excellent customer service.

I will talk more about productivity in a moment but we continue to see benefits that volume brings to our network.

Our high service levels were challenged by hurricane Alex and its impact on south Texas.

Traffic was embargoed over Laredo and Brownsville gateways for most of the month of July which normally handle nearly 50% of our north/south Mexico traffic.

In addition, Eagle Pass our second busiest crossing point was closed for a week before we were able to start using it as a relief valve for our customers.

We demonstrated network resiliency as service improved from August to September once we put the hurricane behind us.

Dialing it down a level the local operating teams are doing an outstanding job on the basic blocking and tackling of local service.

They establish operating plans that meet customer commitments, communicate with customers then execute those plans.

One of those blocking and tackling elements is captured by industry spot and coal which came in five percentage points better than last year even though we tightened the measure.

Consistent with Jack's discussion on record customer satisfaction, local customer satisfaction is also at an all time best.

Different from the broader customer satisfaction measure, this survey solicits feedback from customers we interact with daily at the shipping and receiving docks where the accuracy and reliability of our industry crews is critical.

Quality service is cost efficient.

In the third quarter we leveraged volume through our transportation plans.

Increasing car loadings faster than crew starts as volumes grew 14% in the quarter versus only an 8% increase in total crew starts.

Let me give you a few examples.

First, gross ton miles per employee increased 9% in the quarter as we utilized more employee resources to handle the increased volume but not on a one for one basis.

In fact, this is our strongest quarter of employee productivity in almost seven years.

Train length increased for almost every train type with intermodal and auto up 8% and 6% respectively versus last year.

And with intermodal train length we hit both a quarterly record of 170 units and a monthly record of 171.

Increasing train length enables us to control train inventory levels which is critical to velocity and service.

Freight car utilization remains strong despite a nearly 3% increase in the length of haul.

Prudent use of our working resources enables us to leverage volume.

This slide gives us a quick status update.

In terms of employees we have 1100 on furlough while recall rates have averaged better than 80% this year, the current furlough pool has been out of work since late 2008.

So we expect only about half of these to return to service.

Because of this we were ramping up our hiring efforts systemwide for 2011.

Our locomotive resources are in good supply although the average age of the remaining surplus fleet is about 26 years and we have fully deployed our DP locomotives.

In our freight car storage numbers around 30,000.

The biggest change since the second quarter is demand for covered hoppers to support export grain demand.

Although it's normal for us to have stored cars as a result of seasonality, we would expect a more normal storage number to be around 10,000 to 20,000.

As we approach the end of 2010, I would like you to update you on the progress of our capital program.

We were still targeting approximately $2.6 billion spend this year but allocation of that spend has changed a little.

Replacement capital accounts for 70% of the total with the bulk of that devoted to infrastructure.

Those programs are basically on plan and we see the benefits of that in both our safety performance as well as 20% reduction in slower to miles year-over-year.

We successfully completed work on the new Joliet intermodal terminal which opened for business in August.

We are purchasing 9,200 intermodal containers and necessary chassis' to support this growing business.

And we are acquiring 625 new covered hoppers.

Probably the biggest change from prior estimates is that our 2010 PTC spending will only be around $100 million versus the $200 million originally targeted.

We remain committed to meeting the mandated installation dates but the deployment of this technology is a challenge.

We have encountered delays in design work and material availability related to the fact that this technology is not available off the shelf.

Another change is that we recently resumed working on our sunset corridor which with plans to lay about 16 more miles of double track by year end.

When this is cut over, the 760 mile route will be about 63% complete with more to come in 2011.

Our mission going forward is to continue executing a disciplined operating plan that delivers high quality efficient service product for our customers.

An important element in achieving that goal is reduce variability in our network running a 32,000 mile outdoor factory means that mother nature and other forces can introduce any number of unplanned events because of that it's critical we take the variability out of our operations and take charge of those things that we control.

Along with increasing network reliability we will continue our Evergreen productivity initiatives.

And of course everything we do to deliver efficient high quality service is done with a safety mind set.

Making sure that everyone who works for, does business with or interacts with us does so safely.

So with that, I will turn it over to Rob to take you through our financial performance.

Thanks, Lance.

Good morning.

Today we were following up our record second quarter results with an even stronger third quarter performance.

Slide 22 provides a quick summary of third quarter revenues and expenses.

Operating revenue increased 20% to $4.4 billion as operating expenses grew 11% to $3 billion.

This translated into 46% operating income growth to a record $1.4 billion.

Over the course of 2010, we demonstrated strong volume leverage which is driving higher profits and better margins.

Increased year-over-year diesel fuel prices have been the biggest cost driver for the year and contributed roughly one-third of the quarter's operating expense increase.

Third quarter other income increased $11 million versus 2009 to $25 million largely as result of lower environmental costs as well as higher licensing and rental incomes.

Interest expense totaled $153 million down $3 million versus 2009 as average debt levels were slightly lower year-over-year.

Income taxes increased 62% to $495 million as result of higher pre-tax earnings as well as higher tax rate.

Our third 2010 effective tax rate was 38.9%, which was 1.7 points higher than 2009.

Net income was a quarterly best of $778 million, up 51%.

Earnings per share increased 54% to $1.56 per share.

Resuming our share repurchase program in may reduced our outstanding share balance 2% in the quarter enabling our earnings growth to outpace the rate of net income increases.

Of course a key component of the strong results is a focus on increasing our core rail transportation pricing.

Consistent with our discussions about improving prices in 2010, third quarter core price came in around 5.5%.

Our legacy renewals increased demand and quality service all support the strong value proposition of Union Pacific.

Included in our core pricing gains is the impact of higher year-over-year fuel increases which contributed a little more than half point in the quarter.

This contribution level has been pretty steady throughout 2010.

As we close out the year, we continue to feel very positive about our future pricing opportunities and are committed to achieving real pricing gains that will drive higher returns.

Let's discuss the expense details starting with compensation and benefits at $1.1 billion in the third quarter, a 9% increase versus last year.

Roughly half of the higher year-over-year expense relates to wage and benefit inflation.

We also seeing higher costs as train starts increase generating more starts per employee as well as paying more for overtime and training expenses.

In addition,equity and incentive compensation was a little higher year-over-year driving about 10% of the increase.

Offsetting a portion of these higher costs is our strong employee productivity.

We handled a 14% increase in seven day car loadings with the virtually no change in our total work force levels.

We did add about 9% to our train and engine ranks but that was largely offset by decreases in other areas.

Through a combination of our capital investments, technology and unified plan initiatives, we were handling more volume more efficiently as Lance mentioned we plan to continue recalling furloughed employees as needed for volume and attrition.

We also anticipate further hiring as volumes grow and we exhaust the furlough pools across the system.

Third quarter fuel expense totaled $608 million a 30% increase versus 2009.

Increased year-over-year fuel prices were the primary driver of the higher expense adding $97 million to the quarter.

Higher volumes were also a factor adding about $42 million.

Our efforts to reduce overall fuel usage did help offset a portion of the quarterly costs as our consumption rate improved 1%.

Slide 26 provides a summary of the third quarter expenses for three separate categories.

Purchase services and materials expense increase $52 million in the quarter or 13% to $465 million.

Much of this increase relates to greater contract service expense associated with year-over-year volume gain.

As our intermodal business continues to grow, trucking and lift costs are higher.

And as we return more stored locomotives to service, both contract services and materials expense increase.

Equipment and other rents expense increased 1% or $2 million, the $292 million.

The biggest increase in the quarter was car hire expenses associated with increased finished vehicles and intermodal shipments.

Largely offsetting this lower lease expense for locomotives for freight cars.

Other expense totaled $178 million consistent with the guidance that we previously gave you down $1 million versus the third quarter 2009.

As we have discussed the last several quarters, this category continues to benefit from our strong safety performance.

State and local taxes mostly driven by higher property taxes came in higher year-over-year.

For the fourth quarter, we think that other expense will be around the third quarter levels.

UP's third quarter operating ratio came in at a new best ever level of 68.2%, 5.6 points better than last year.

This is our second consecutive quarter with a sub 70% operating ratio as we continue to drive improvements across all aspects of our operation.

Our ability to efficiently move growing business volumes at better pricing and better fuel surcharge recovery is driving greater profitability for Union Pacific.

This is consistent to improve our commitment to overall returns in our business as well as achieving goals of our operating ratio initiative.

Along with Union Pacific's increased profitability comes greater cash generation.

Through the first nine months of 2010, cash from operations totaled $3.1 billion up more than $700 million compared to 2009.

Free cash flow after dividends is up substantially as well totaling over $1 billion even as we support our 2010 capital program and increased dividends 22%.

We are also continuing to return cash to share holders through our share repurchase program.

We are being opportunistic with our program buying back more than 14 million shares year to date for a total of $1 billion.

Through September, our average 2010 purchase price was around $72.50 per share and roughly $65 per share over the life of the program.

Our commitments to maintaining a strong balance sheet and investment grade credit rating are also still very much in focus.

Our adjusted debt to cap ratio of 44% is in the range it supports rating we believe is appropriate for our business.

Let me wrap things up with a few thoughts on the fourth quarter.

As Jack discussed earlier, we see solid year-over-year [volle] growth opportunities to close out 2010 even against our toughest comparison of the year.

Of course, normal seasonal trends are expected to hold which would likely produce a seven day volume run rate in the fourth quarter that is below the third quarter levels.

With car load growth we expect continued leverage although against a tough comparison as well.

As you heard from Lance, we have largely depleted our furlough pools so it will be necessary to ramp up our hiring programs to handle more business as well as back fill for attrition.

We also have the additional cost of more locomotives and freight cars in service as well as slightly higher fuel costs.

Against those cost head winds we believe we can achieve strong productivity as well as see benefit of ongoing pricing gain.

Overall, we were looking forward to wrapping up 2010 with a strong fourth quarter performance.

We are keeping an eye on the economy and particularly as we start putting together our plans for 2011.

While car loading activity drives direction of our earnings, cash flows and returns we are committed to creating value for our share holders.

With that I will turn it back to Jim.

With just a couple of months remaining this year, it's probably safe to say that we are on pace to make this a best every year for our railroad as the economy continues to grow we were ready to safely and reliably haul more freight.

The infrastructure investments we made in the last several years enable us to operate more productively and greater reliability.

With that comes better service to our customers which increases UP's value proposition and financial returns.

Men and women of Union Pacific are dedicated to serving our customers and delivering the goods that are vital to the nation.

It's been our business for 150 years and we look forward to continuing that success in the future.

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

(Operator Instructions) Thank you.

Our first question is from John Larkin with Stifel Nicolaus.

Good morning, gentlemen.

Terrific quarter.

Just wanted to get a little feel for the financial impact of hurricane Alex.

It sounds like it was pretty disruptive down along the Mexican border.

Care to share with us how much that may have impacted the operating ratio?

Well, I mean, clearly there was an impact on the numbers.

But it was relatively minor on the costs.

The bigger issue for me was maintaining the customer service and commitment to our customers.

When you had that border closed, we had many of our auto facilities were at risk closing down because of parts and -- our team did a good job though of keeping things moving.

We got great feedback right back from our customers.

So profitability was perhaps shifted from July into August and September?

There was probably some shift as Jack had mentioned on the auto parts.

If you looked at it auto parts were flat year-over-year.

Now some of that may have gone highway when you look at it.

Again, it was relatively minor.

And maybe as a follow on, perhaps for Jack, Jack had mentioned that the intermodal peak seems to be lasting perhaps a little longer than you had originally talked about.

There has been a lot written in the press about the peak being pulled forward, any thoughts as to when that's going to be tailing off and rather -- whether or not the retailers perhaps ordered a bit too much and will end up with overstocked inventories which could potentially slow intermodal down as we get into the early part of next year?

John, it's pretty early to tell -- the jury is still out on whether or not they have ordered to much.

What our intermodal ocean carriers have told us is -- at least some of them have told us, they expect their ships to be relatively full for as much as another 60 days which usually by now you're starting to see the percentage of capacity starting to slip down a bit.

So that's pretty good news for us.

And we are watching very carefully in terms of the inventory sales ratios and things like that, there is certainly nothing there that alarms us and tells us that we are going to be heading on a downturn here.

We are feeling pretty optimistic right now.

Thank you very much.

Or next question is from Ed Wolfe with Wolfe, Trahan & Co.

Please proceed with your question, sir.

Good morning, guys.

It's [Scott Griffin] for Ed.

If I look at margins the past five or six years or so, fourth quarter tends to be little bit better than third quarter.

Rob, you talked about cost head winds coming in fourth quarter.

Do you think that dynamic plays out differently this year and fourth quarter margins are worse than third quarter?

Scott, fourth quarter is not always -- a lot of things can happen in the fourth quarter to us, weather and volumes obviously will be a key driver.

It's not always true that the fourth quarter is better.

It's probably 50/50 to be honest if you looked at a longer historical issue and recall that last year we had a fairly sizable favorable adjustment on the PI, personal injury and asbestos.

So we aren't making progress in terms how that is going to play out this year, but just keep that in mind as you look at the comparison versus last year's fourth quarter.

Okay.

That's helpful.

And then, Rob, I didn't hear the breakout of fuel and mix and overall on the business.

I'm wondering if there is any negative mix impact in intermodal.

I guess we were just a little surprised that yields were -- revenue per car was flattish from second quarter despite putting in some rate increases and some peak surcharges.

Overall, we said that fuel contributes to our overall arc about 5 points.

And there was overall negative mix of about 3 or 4 points which is a result of the strong growth in the overall intermodal and some of the mix impact that Jack talked about in our industrial products line.

Jack, you want to talk about the intermodal specific?

This is Jim.

I think you need to look at the chart Jack had in there showing the core price numbers.

That really takes mix out of the equation.

Fact of the matter is our core pricing numbers were up compared to second quarter.

You really do have to watch with mix on an average revenue per car basis.

As we commented our core price was up.

Anything specific in intermodal?

If you just looked at intermodal, Scott, the only thing that was a mixed impact was the strength of the international business where we still have a legacy contract impact there.

And that grew quite well in the third quarter which created some negative mix.

We still had positive price in both our domestic and our international business.

That stronger international is masking some of the strength in the domestic rate increases you put in?

Yes.

Okay.

Great.

Thanks, guys.

Thank you.

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

Good morning, everyone.

First question is on the -- you guys are doing a great job obviously on the operating leverage side with excellent productivity.

I think you mentioned best since seven years on the employee productivity.

My question is on the sustainability of that and obviously you have run through your furlough pool.

You are going to be hiring or potentially hiring new employees that presumably need a little bit more training.

What is this sustainability of your -- of this operating leverage trend and do you think that productivity level gets worse with more volumes?

Or stays the same?

Or might even get better with higher volumes?

As we look forward, Walter, we don't see any reason why productivity can't be sustained.

Now, that doesn't mean necessarily sustained at the same rate that we have seen through this year as volume first started returning.

For the long run we anticipate we are going to continue to be able to use our assets productively both employees as well as fixed assets.

Some of those ratios could come down as we continue with higher volumes?

It's reasonable to expect that the ratios start slowing down a little bit.

Walter, there are still good ratios.

I'll give you an example.

We are hiring now for next year.

You are going to see more people in the classroom getting trained.

It's all our assumption next year but -- and it's not a linear relationship.

The costs in this business are a step function out here.

Even though you will see some of those costs increase, we are still going to have very good leverage.

Now that's great.

Second question here, I guess, Jim, on regulation, when -- obviously this is an election year, it's not going to be the re-reg -- the Surface Transportation Board Reauthorization Act is not going to be top of mind until this is done.

When you look out to 2011 and I know -- we know your positive view on rail and all the benefits that that offers, but what is your strategy when this starts to creep back up again in 2011 and listen to what Rockefeller is saying about using regulation as opposed to legislation.

Can you talk about the railroad industry strategy in 2011 when this starts to resurface again?

Well, it's really no different from where we have been the last couple of years.

We are engaged with Senator Rockefeller.

The main item is tell the story.

By any measure when you look at the success of deregulating the industry it's an absolute great story.

If you look at new investment that's gone into the industry.

The private sector and if you agree the country has an infrastructure problem, there is a lot of private money that's gone into new investments.

Keep them engaged.

Provide great service.

Keep our customers engaged in terms of where investment is going.

And also point out if they get it wrong, we will go backwards.

We will go backwards and investment will go backwards in jobs.

But are you worried about the regulation strategy that he has talked about?

I have to tell you when I think about the problems in this country, I have a hard time saying where the issues of the railroad are on the top 50 list.

It doesn't mean we don't pay attention to it.

But we stay focused and engaged.

Good answer.

Thank you very much.

Thank you.

Our next question is from the line of Tom Wadewitz with JPMorgan Chase.

Please proceed with your question.

Good morning.

Let's see, I wanted to ask you little bit about I guess train length.

I think you've seen some nice expansion in train length, particularly in intermodal this year and maybe where you are at as you go into next year, is there still a big opportunity to run longer trains and have a good ratio of volume growth to train starts?

How would you think about that as a driver of leverage in 2011?

Tom, our train length opportunities still exist as we go into 2011.

Specific to intermodal, we still have a upside, it depends on where the business comes in terms of the lanes in quarters that those trains run in.

But across the board, across all our product mix we still have train length opportunities and it still will be an important part of our productivity improvement.

Okay.

As a follow-up question, on the cost side when I look at comp and benefits you had pretty big increases on a per worker basis this year.

I think a lot of that is incentive comp but you also have transitioned to a half year impact from a strong wage increase to this Cola period while you're negotiating.

How should we think about per worker cost next year when you consider wage and inflation?

Is it kind of 2 to 3%?

Is it a little more than that?

Presumably it's a lot lower than what you have seen this year.

Tom, first of all the increase is not a function of incentive comp.

It's a big driver.

As Rob mentioned, it was -- the increase third quarter is about 10% of that gross.

Take it off the table.

You obviously are finally cycling, you had 4.5% increase on the labor agreement that's out here.

We had a lot of overtime.

We have been pushing the overtime curve here in terms of absorbing some of the volume.

That's out of here.

Our health care costs have jumped up pretty substantially here in third quarter.

You look out to the future.

Our inflation number that we look at is in that 3.5% to 4% range.

That's what you have to think about.

Now that again, we still have productivity and our targets when you work in the railroad and you lead a department as you offset inflation in terms of productivity that's obvious.

But you're saying 3.5% to 4% per worker?

It's going to vary on mix.

I'll give you an example.

If you look at what Rob was talking about earlier, we increased our hiring in terms of numbers on train and engine per employees.

They have a tendency to have the highest average earning if you are out running on the railroad.

You can get a mix impact there that will drive that cost up also.

Okay.

Great.

Thank you.

Our next question is from the line of Gary Chase of Barclays Capital.

Please proceed with your question.

Good morning, gentlemen.

This is actually [Brandon Oglenscki].

Can we talk a little bit about export grain?

I know the Russian moratorium came into effect around mid-August.

I was wondering if looking into 4Q if there is any equipment or port availability that is really going to limit the growth there?

Then secondly, we've seen some activity in your grain tariffs.

I was wondering if you could comment a little bit further about that?

I caught the beginning, the second part of your question, Brandon, I wasn't clear on.

We've seen a little bit of activity in the grain tariffs and I was wondering if you guys are expecting to monetize a little bit more on the ag side in the fourth quarter?

Yes, okay.

At this point in time in terms of equipment supply, those kinds of things, we were pretty well equipped and ready to run.

As Lance said, we pulled the C5's and some C4's out of storage.

We still have a few more that we could if we need to.

In terms of overall port disruption, it tends to be episodic, actually.

There is a problem at the Port of Houston with an electrical outage for four days.

Some of those kinds of things.

Overall, ports seem to be running pretty well.

I don't really see any major obstacles there.

Although, it did impact our losses to look at the customer queueing piece in terms of grain.

It did but it isn't episodic.

It's not something fundamental or from an infrastructure perspective that I think will be causing us to miss a forecast or not take advantage of the market opportunity and in terms of the tariff, we are watching that very carefully.

We are taking opportunities to increase our rates as necessary.

And as available to us and being very careful as we think through our commitment to customers and also what the market has done.

Thank you.

And then maybe just a little bit further on the labor side.

I know you guys said you are going to be looking to hiring a few more people next year.

I was wondering if you could balance that against the attrition level that you guys are expecting and maybe give us an idea how head counts should be trending?

We are going to lose -- our hiring this year we are going to end up with about 1,700 new hires to the Company.

I would expect our fourth quarter employment levels probably to be up a little bit from where we were.

We are flat year-over-year.

Next year our attrition number is going to run around 3,500 to 4,000.

We clearly are going to keep -- again, let's assume what are we thinking economy next year.

Still pretty cloudy.

But I still believe you are going to continue slightly positive as you think.

So we are going to have a pretty strong hiring program and again, if volume is up we'll probably see our employment numbers up a little bit.

Somewhat of a one for one match there on the attrition rate then?

In some cases we are taking advantage of attrition in terms of our productivity initiatives when you look at it.

We won't hire again if you think what we are talking about on train size and productivity there, you won't have a one for one with volume there.

But again what your assessment, I'm not going to make a prediction in volume other than I think it is going to be positive.

And we will be up a little bit next year.

Thank you.

Thank you.

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

Baird & Company Inc.

Please proceed with your questions.

Have you seen any change in the ocean liners attitude as far as sending their international boxes inland and any signal on the horizon that that may or may not change as you go into 2011?

Jon, the fundamental change that took place was early in the year when some of the ocean carriers decided the best course of business was to transload at the port and then turn around and send the boxes back.

So that happened.

Nothing really substantive has changed as we've gone through the year.

Some ocean carriers allow their freight to move inland.

Others are preferring to transload on the West Coast.

We did notice particularly this year -- this quarter the -- a stronger move of empty boxes back, the revenue empties that we moved to the West Coast was much stronger which said basically they weren't willing to allow the term -- the containers to sit and look for a back haul load.

They would rather expedite it back to Asia so they can turn the box again.

Other than that there really hasn't been any substantive change as we have gone through the year.

Then if you think about the intermodal investments you guys have obviously made a number of investments there with the Joliet facility and further investments in the Sunset Corridor, but as you think about the next three to five years, what are the incremental growth investments that you look to make on the intermodal side?

Well, John, in many ways other than an intermodal facility, it's all interrelated.

When we look at, for example, our Sunset Corridor that Lance had talked about that we have started back up are going to do about 16 miles of new rail this year.

Other products move in that line.

You step back in the network and -- when we think the next three to five years you have to think holistically.

How will all six businesses grow.

How do you manage the network in terms of the choke points.

I'm pretty bullish when I think about the next five years for this business that rail is going to grow its share of total intercity business and we are going to invest accordingly.

The key in this business is service.

We want to stay ahead of that curve to provide great service.

We see value in terms of our yields for it and great growth.

Any need for -- that you see on that horizon for the significant terminal buildout beyond what you have already done adding on to existing facilities?

If you are talking intermodal we have some targeted areas we are looking at.

We are out right now looking at property for the long term.

Think about what's happening with property values right now.

Now is a great time to be in that market when you think strategically.

You can acquire property in some of these locations at $0.50 on the $1 from where it was three years ago.

We are making acquisitions today that we are looking three, four, five six year out that we would need.

Thank you.

Our next question is coming from the line of Chris Ceraso of Credit Suisse group.

Please proceed with your question.

This is Allison Landry in for Chris.

I had a question regarding the international intermodal.

You mentioned you should be seeing continued strength.

The inbound container data for the ports of LA and Long Beach actually declined pretty significantly sequentially in September from August.

I was wondering if you could comment on that inconsistency?

I have I not seen that in our numbers.

Okay.

The only issue but was that this would be in early October.

The impact of the typhoon, the three day impact of the typhoon in Asia and then also the golden holiday in China.

In the September time frame I didn't see a significant impact to our numbers at all.

Okay.

And then can you remind us when the legacy contract in the international intermodal rolls over?

We don't get into individual contract discussions.

Okay, that's fair.

Thank you.

Our next question comes from the line of Bill Greene with Morgan Stanley.

Good morning.

I want to follow-up on the intermental margin question, it seems like there's an assumption that they will come down from the 60% rate.

Yet you still have more business to reprice and arguably you could theoretically get more productive.

Is there a case for arguing that they actually stay or even accelerate from here?

How do you think about the trajectory of incremental margin?

My -- our comments on that margin were more related to when you think about the productivity leverage.

We clearly have opportunities on legacy pricing.

We have opportunities in terms of when you look at demand but the discussion I was thinking about and we're actually talking through is if you -- holding pricing firm, how do you think about productivity expanding or contracting the margin and as we talked earlier as you move up that capacity curve you are going to start to add few more costs in.

That doesn't take into account what will happen with the pricing numbers.

That possibility is clearly there.

Bill, this is Rob.

Just one other point to keep in mind.

As we performed well throughout as the economy turned down, other comparisons get more difficult too each quarter.

That's just something else that is a factor in that.

And there is another piece here, when you think about -- when you start pushing up in that 190,000 car range or 195,000, what is that saying about overall demand which should say that's a better pricing environment overall for our capability.

So Jack and his team have -- Lance has the challenge with productivity.

Jack and his team have the challenge of continuing to drive prices up that reflect demand.

So that actually leads to the second question which is you've talked for awhile now about accelerating pricing and we saw that again this quarter.

When does it sort of peak out?

Are we there?

Is there more to go given the legacy repricing and whatnot to come?

Yes.

Bill -- let me -- just to kind of reset the table here, when we talked about accelerating pricing that was when we had a 3.5% core price in the first quarter what we said at that point in time which was the only guidance we gave on pricing is that we expected throughout 2010 for that to increase and in fact, that's in fact what we've seen.

5.5% core price in the third quarter is evidence of the fact of that expectation.

And you aren't saying anything beyond that?

No, that's right.

Thanks, Bill.

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

Please proceed with your question.

Hi, good morning.

Solid results.

Jack, let me jump on the coal comments you made earlier.

Sounds like with you noting some mine downtime, some inventory levels being low, any chance for increasing coal export on the West Coast first and then second it just seems like you are setting yourself up for some pretty improving demand on the coal side; is that what you would anticipate?

Ken, we're probably going to do about 1.5 million tons in export coal this year, but we were working diligently with potential developers of port capacity which is kind of our biggest choke point to move off the West Coast and we are getting some bites there that we think are pretty attractive and pretty interesting.

We are hopeful that we are going to see export coal improve from the Union Pacific franchise perspective so that will be a good thing.

And, yes, secondly, we saw the impact that weather could have last winter when we went from 75 days down to basically on plan from a stockpile perspective.

But right now the way things are shaping up through the first quarter our coal demand looks pretty solid.

Much better than where we were a year ago.

And hopefully that will continue.

We will have a -- I hate to say this, everybody in the room will throw daggers at me but I hope we have a nice, cold long winter and that will help us again.

Great.

Let me get a follow-up with Lance on the equipment side.

You gave numbers for employees furloughed and cars.

What about locomotives still in storage?

I just want to understand how much you have left and then it sounded like you were reducing your spend on PTC.

Is that -- I guess maybe for Jim I will throw it out there.

Is this something you are still working with the regulators to say, hey, the technology is just not there, we can't yet meet those deadlines or do you just keep pushing it back and hope things get developed in time for the 2015 deadline?

In terms of locomotives in storage we have got somewhere between, call it 850 to 900.

I will remind you that those are older locomotives I mentioned in my comments, the average age is 26 years.

We've got all of the DPU capable and high efficiency units out and running.

We do have 850 plus that are available to us.

Ken, this is Jim here.

Keep in mind, we did talk about we are looking at maybe acquiring 100 new locomotives next year.

Efficiency, emissions requirements, long term that's out here.

On the PTC question, it's a combination of several things in terms of going from $200 million to $100 million design resources.

Just overall the complexity of the system has blown the deployment down a little bit.

We are doing everything we can in terms of getting this thing to reality.

The regulatory discussion or political discussion will, I think happen more next year when the FRA is going to be required to meet -- we are going to all look at certain checkpoints and you will look at the feasibility of the technology.

Unfortunately we are spending a lot of money to try to get it there.

If I can add, our expectation is that it's in that $1.4 billion capital spend for us over the next several years.

All right.

Great.

Thanks, guys.

Thank you.

Our next question is from the line of Cherilyn Radbourne of TD Newcrest.

Plead proceed with your question.

Good morning.

I was hoping you could comment on the degree to which you got price visibility for 2011 as we sit today based on contracts that you have ruled.

We are not giving guidance on future pricing other than we think we have the capability at real price.

We are seeing very good yields on new products we are putting in the marketplace that directly reflect the service that we put in.

I'm feeling pretty good about our capability.

We have to perform servicewise and honestly, we need to get the pricing returns up if we are going to justify the capital we are putting in.

My next question was whether you could just comment briefly on your new ad campaign and what you are hoping to achieve with that and whether you've made any sort of accompanying changes, organizationally to sort of deal with the historical criticism that rails are inflexible and difficult to deal with particularly for customers who aren't big users of rail and small customers?

We did quite a bit of research before we kicked the campaign off and guess what, we confirmed what you just said.

That a lot of cases customers have some beliefs that they don't have a track outside their warehouse.

They can't do business with railroad or they don't think they are big enough in terms of doing business with railroad or we are tough to deal with.

The goal of the campaign, there are three objectives.

One, to really help a very large addressable market understand that they do have an option for rail.

And that's a complete logistics solution.

We feel that there is a lot of capability there.

Second and I want to increase the awareness from the local mayor to the state senator about how important rail is in terms of the business we do.

As you probably -- it wouldn't surprise you many folks, their experience with rail is they are sitting at a sighting and they don't really see the clarity of how important we are and third for us is employee pride.

We have got a lot of leverage going with the service and a lot of our employees are interested in how do we grow and add jobs into the Company long term.

Those three factors come into play.

We have changed the organization.

We have got an on boarding team, we've got a new website.

A microsite in terms what we are doing.

Jack and his team have added resources that the worst thing you do is you put an ad campaign out and a customer makes a call and you frustrate them.

That's the easiest way to failure.

We are pretty pumped up by it.

In fact, some of the earlier calls a lot of this is not just intermodal when you think about the capability.

But some of the earlier calls were opportunities in the car load network.

That's great color.

Thanks.

That's all my questions.

Thank you.

Our next question is from the line of Jeff Kauffman with Sterne Agee

Most of our questions have been answered but we had a quick question on equipment runs.

On a GTM basis it looks like it was down double digit in 1Q and 2Q and then midsingle digit in 3Q.

Kind of curious, is that supposed to grow more in line with volume soon or how should we think about that?

It should go with volume.

You can have a mix effect depending on what equipment it is moving.

Whether it's equipment that in fact has rents associated with it or whether it's something that doesn't.

Of course we are always focused on offsetting any increase in equipment rents with productivity but it will -- the bottom line is it will grow with volume but there is a mix affect in there.

Okay.

That's all the questions.

Thank you.

Our next question is from the line of Anthony Gallo of Wells Fargo.

Plead proceed with your question.

Good morning.

I guess it's a two part question that I will count as two questions.

Operating margins are 780 basis points better than they were in the third quarter of 2007.

I think you said car loads were about 8% or 9% below that level.

If you can bridge us to where we are today and then look ahead, price productivity costs were key components of the margin improvement over the last couple of years.

How might that mix of those factors change going forward and would you care to bucket them for us historically?

Well, Anthony, I'm not going to give specific guidance on the pricing.

Although clearly you go back two or three years ago we had a bigger book of legacy opportunity.

So legacy in terms of driving some of the price was greater then than it is today.

Again, we still have a nice book of legacy business out there.

As I said earlier, we are seeing very good price capability for the service and the value and the products we are putting in.

It will be part of the equation going forward here.

Maybe a little less than where we were in '07.

But part of that is your assumption where you think volumes are going.

Get out two or three years from now, if you believe as I do that rails got to have a greater share of intercity freight and the demand will grow, I think the pricing number could be pretty strong.

Okay.

Then on the productivity side, is it fair to say that it wasn't meaningful?

2007, 2008 where as right now it's very meaningful and how do you want us to think about the productivity piece of it going forward?

As you may recall, we launched an effort called project operating ratio and in fact, one of the things that we think serves us extremely well is we launched that effort prior to the economic downturn and what that effort was was we enlisted all 40,000 plus of our employees to tackle everything they do from productivity to adding value to the customer which we know is important to improve our service and add value on the pricing front.

We felt good coming in to that economic downturn and certainly by the time latter half of '08 came around that was well underway and had a lot of momentum.

Yes, we've made progress compared to that '07 time frame but I wouldn't characterize that that was the depth of our productivity either.

Can I add one thing.

The other thing to note is you look at our key measures from the operating perspective we have been demonstrating productivity improvement steadily since 2007.

Perfect.

Thank you.

Thank you.

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

This is Rob on for Justin.

You guys have talked a lot in the past and on this conference call about the improvements you've made on the service front which has helped driven market conversion on intermodal in particular.

How do you think about guaranteeing service levels and in an environment where the ocean liners may no longer provide the chassis on intermodal and how do you think about that potential change affecting the intermodal landscape and the ability to provide service?

Your call was breaking up.

What was your name, was it Rob?

It's Rob, sorry, I'll repeat it.

You guys have talked a lot about the improvements you've made on the service front which has driven market conversion on Intermodal in particular.

How should we think about your ability to guarantee service levels in an environment where the ocean liners may no longer provide chassis and how do you think about that kind of impacting the overall network?

To the extent that it's necessary we are investing both in boxes and chassis and creating universal chassis pools to improve the efficiency and the effectiveness of the utilization of that asset.

I think we were covered.

Sounds good on that front.

And then if I look at the productivity measures, you guys drove some solid improvement on the gross ton model per employee, even sequentially from Q2.

Could you give us a sense if there is anything incremental that was implemented from Q2 or is this primarily the benefit of the volume leverage?

I think a big piece of it is the volume leverage but if you step back a minute I would also point to things like our unified plan, it goes to our infrastructure investments we've made over the years.

It goes to coordination between marketing operation and the products we are putting in.

This is a business that leverage with volume to a point.

You can also reach a point that you start to see negative productivity if you overload the network.

The key is managing that network to its maximum efficiency point on the capacity curve.

Appreciate the time.

I guess the final piece to the question, tax rate was a little bit higher than we have been expecting in the quarter, could you guys comment on what we should be thinking about for Q3?

In the third quarter the reason it was a little higher was because it was related to state taxes and some timing issues within some of the states.

But looking forward I would bank on around a 38% rate.

Thanks a lot for the time, guys.

Thank you.

Our last question is from the line of George Pickral of Stephens Inc.

Lance, one question for you.

Of that 30,000 containers that are -- cars that are still parked, is there any one specific type that you may have more of parked versus another?

I think you mentioned you're actually buying covered hoppers and intermodal containers.

I imagine you have got little to none of those parked right now.

The mix of what's stored right now in terms of freight cars varies.

With lumber down we have got a fair amount of cars that are used for transporting lumber.

With the automotive finished good down we have got a fair number of auto racks that are stored.

You are right.

There is definitely a differentiation in the type of cars that we've got stored.

What about coal?

Pretty de minimus at this point.

Some but that's not a majority.

George, I think that's a good example when you start thinking about being productivity in the future.

I think it's a good example where depending on where the growth comes, you have more leverage in other areas.

Look at lumber.

Lance mentioned we have got center beam flat cars, our lumber loadings are only about 20% to 25% where they were in the peak back in '06, '07.

If you see your lumber business pick up, you should see pretty nice leverage on that particular group.

You've got excess equipment sitting around.

We have capacity in our yards.

We still have our -- of our 111 principal yards we have about 23, 24 that are very much underutilized.

We have got good upside there.

Great.

Thanks for the time, George.

Thank you.

There are no further questions at this time.

I would now like to turn the floor back over to Mr.

Jim Young for closing comments.

Thank you for joining us today.

I hope you are happy with the results.

We are going to continue to focus on improvement in this Company and look forward to talking to you in early January.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.