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Kansas City Southern (NYSE:KSU)

Q4 2012 Earnings Call

January 22, 2013 08:45 AM ET

Executives

David Starling - President and CEO

Dave Ebbrecht - EVP and COO

Pat Ottensmeyer - EVP, Sales & Marketing

Mike Upchurch - EVP and CFO

Jose Zozaya - President and Executive Representative, KCS de Mexico

Analysts

William Greene - Morgan Stanley

Allison Landry - Credit Suisse

Chris Wetherbee - Citigroup

Thomas Wadewitz - JPMorgan

Matthew Troy - Susquehanna International Group

Brandon Oglenski - Barclays Capital

Ken Hoexter - Bank of America Merrill Lynch

Scott Group - Wolfe Trahan & Co.

Doug Karson - Bank of America Merrill Lynch

Keith Shoemaker - Morningstar

Tyler Brown - Raymond James

Brad Delco - Stephens Inc.

Operator

Greetings and welcome to the Kansas City Southern Fourth Quarter and Full Year 2012 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the company which could materially differ from the events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factor section of the company’s Form 10-K for the year ended December 31, 2011 filed with the SEC. The company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to the GAAP could be found on the KCS website, www.kcsouthern.com.

It is now my pleasure to introduce your host, David Starling, President and Chief Executive Officer for Kansas City Southern. Mr. Starling, you may now begin.

David Starling

Thank you. Good morning everyone. Joining me on the KCS fourth quarter and full year 2012 earnings call are, Executive Vice President and Chief Operating Officer, Dave Ebbrecht; Executive Vice President, Sales and Marketing, Pat Ottensmeyer; Executive Vice President and Chief Financial Officer, Mike Upchurch and with us here today is José Zozaya, our President and Executive Representative of KCFM who will be available during the Q&A period.

Turning to the KCS’ overview; I am pleased to be able to say that despite weakness in utility coal traffic and the adverse impact of one of the worst droughts in US history on our grain business, KCS had another outstanding year in 2012. Record car loadings and revenues along with strong operating performance and a stable pricing environment resulted in a full year adjusted operating ratio of 69.9. Let me be clear on this case, the adjustment actually resulted in a higher operating ratio.

Our reported OR was 68 but when you exclude a one-time benefit from the elimination of the net-differed liability that we explained to you in the second quarter, adjusted number is 69.9. This is a historic achievement for KCS and it marks the first time this company has had a full year operating ratio below 70.

We are both very proud of this accomplishment as it took the combined efforts of both our Mexican and US employees.

Obviously, the continued strong performance of KCS has been recognized by investors. While this is gratifying and appreciated, all of us both you in the financial community and we at KCS are now focused on the future. For that reason, our presentation this morning is as much a look ahead as it is review of the fourth quarter in 2012.

We want to emphasize yet again that the KCS growth story is by no means slowing down; really it’s just the opposite. While there many factors that go into an investment decision, we believe that KCS will have the kind of escalating business growth that will continue to make this company at very viable investment option. As the year goes by, we’ll talk about many of the specific opportunities that compromise our growth story. But today we’ll start by giving an overview of what you can expect for the year.

In the next slide we’ll talk about the fourth quarter results. I won’t spend much time going over the fourth quarter results other than to say our revenues grew by 7% on a 2% increase in carloads. Given the droughts, the continued pressure on our utility coal franchise and the uncertainties prompted by fiscal cliff concerns, we’ll take those numbers any day of the week.

Our performance clearly speaks to the diversity of our commodity mix and the continued economic expansion of Mexico and our unique position in both facilitating and benefiting from that growth. KCS’s operating ratio for the fourth quarter was 69.5, which was a 2.1 point improvement over fourth quarter 2011.

Finally, our reported diluted earnings per share was $0.83, compared with $0.87 last year. With this reporting period, we’re changing our adjusted diluted earnings per share calculation which essentially neutralizes the foreign exchange impact on our tax rate. Doing this result in an adjusted diluted earnings per share number for the fourth quarter 2012 of $0.92 compared with $0.77 for the fourth quarter of 2011. We believe that once you become familiar with this calculation, you’ll like it as it puts our effective tax rate into a much more narrow band which will make it easier for you to understand the true earnings power of KCS. Mike Upchurch will discuss this more during his portion of the presentation.

On the next slide full year 2012 results, KCS revenue grew by 7% on a 5% growth in carloads. As I mentioned earlier, our adjusted 2012 operating ratio was 69.9, a 2.2 point improvement over last year’s adjusted number. Our reported diluted earnings per share for 2012 was $3.43 compared to $3 in 2011.

Under the adjusted diluted earnings per share calculation, again to neutralize the F/X impact on our tax rate and earnings, EPS was 356 for the full year 2012 compared with 290 for 2011.

In the next slide, the update for full year 2012, in keeping with our practice of reviewing our performance relative to the guidance we provided, I can say that we clearly hit the targets we laid out during the second quarter when we revised our revenue guidance downward somewhat based on a number of factors, but most notably due to lower than expected coal revenues. Our 5% growth in coal load is about is mid-single digit as you can get.

Pricing was also in the mid-single digits range somewhat closer to the lower end of the 4-6% spectrum we used to define mid-single digit. Revenues came in at 7% for the year, a little higher than the mid-single digit guidance we gave.

And finally we improved our operating ratio by 2.2 points. All in all KCS has had a good year and we think 2013 can be even better which is my queue for turning to the next slide.

Let me preface our 2013 guidance with a few general comments. during the past year I referred to 2012 and 13 as bridge years leading up to 2014 when a number of new business opportunities come online. While we all stand behind that assessment, no one should interpret the term bridge year especially as it pertains to 2013 as suggesting that KCS will be in a low growth environment. The truth is 2013 should be a strong growth year for KCS.

In 2013, KCS expects to achieve mid-single digit volume growth along with mid-single digit pricing. The dynamics of KCS pricing are slightly different than that from some of our class I colleagues. In the US KCS is really no different from the other railroads. With a total absence of inflation in the US, rates are definitely at the lower end of the mid-single digit band.

In Mexico, inflation is running around 3.5% which means for that alone we can expect somewhat higher rates. in addition, KCS aims very low loss and damage expense in its good service metrics helped with pricing, so when we put the pricing scenarios of our US and Mexican business together, we are still on that mid-single digit range.

We’re looking for revenue growth to be high single digit, somewhat higher on a percentage growth basis than 2012. Our operating ratio will continue to improve given that we’re starting from a base in the 60s, we’re most comfortable saying the KCS’s operative ratio will continue to improve during the years ahead. While I would rather avoid laying a specific target number out there, you should assume that we plan on continuing to improve our margins well in to the future.

Finally, looking forward to the significant increase in traffic we see coming in 2014 and beyond, we are planning for a capital spending to come in a bit above 20% of revenues.

And finally, KCS had a good 2012. We believe that 2013 would be even better and it only gets more exciting beyond that. With that, I will turn it over to Dave Ebbrecht.

Dave Ebbrecht

Thank you, Dave. Turning to slide 11, I would like to address our consistent ability to control cost. Ops cost continues to remain relatively flat over the past three years while our growth in Linehaul Revenue scales well above our cost.

Initiatives in network train management, terminal efficiency, fuel optimization, capacity enhancements and equipment utilization have resulted in greater fluidity and headcount stabilization. Our expense management and cost control in all of these variable operating areas continues to be a major driver of our overall improvement and we are proud of all the hard-work the team has contributed towards achieving an OR below 70.

On slide 12, you can see the results of our headcount controls. Our headcount actually decreased year over year with an increase of 5% car loadings. We will see occasional dips in this efficiency metric due to seasonal variations in car load ship from quarter to quarter but the overall trend will continue to remain very positive.

We have been hiring in the areas that we are experienced in high growth rates but most of our hiring is still just for attrition purposes. We are also evaluating our contract services that may increase our headcount by taking some work in-house.

Another key point to emphasis is that while we continue to become more productive, we improved our safety record last year which was our sixth consecutive year winning Gold (inaudible) award.

Flipping to slide 13, I want to emphasize the importance we played some modeling growth predicting capacity needs and executing a just in time approach towards our capital investments. I have given some details here on the major areas we are investing in capital over and above our normal maintenance capital.

The investments in double track and CTC significantly increases our ability to handle much larger volumes of trains. Also we are investing in equipment for auto and intermodal growth while we optimize the use of our existing fleet.

We are seeing very positive results in market capacity investments we made in 2012 as indicated by its significant increase in our train velocity in the attached chart. We look to achieve even greater fluidity in the upcoming years with our significant growth opportunities.

On slide 14, you can see our operating metrics to continue to remain in a very good range for the fourth quarter and for all of 2012. As I just discussed, velocity set a new record averaging above 28 miles per hour for the fourth quarter. Dwell and Car efficiency are in the range we need them for execution of our service plan, the main way Slow Order Miles are also in a very good range. We did have some issues for the heat orders during the summer and we had some heavy maintenance sway activity on the (inaudible) sub-divisions, but the slightly slower tracks speed have had no material impact on velocity in Dwell.

We’ll continue to scale the cost below the growth projections in 2013 and look forward to having another great year. Now, I’ll turn it over to Pat for the sales & marketing updates.

Pat Ottensmeyer

Good morning every one, I will begin my comments on slide 16. As you have saw earlier, revenues for the quarter increased by 7% from last year on a volume increase of 2%. This slide shows you the details by business units and I think what's most remarkable about this quarter is we have very good performance overall in spite of weakness in our coal and grain business which represents about 18% of our total revenues.

I’ll just touch briefly on some of the highlights for the quarter. We had good revenue per unit gains across the board, which was a function of mix particularly in energy, longer length of haul and higher pricing. And chemicals and petroleum part of the story for this quarter is weak, weaker comps in 2011. You may remember toward the end of last year, we told you that our business in this area was negatively impacted by some temporary factors like plant outages and customer disputes. We do not have factors this year so our business was sort of back to normal.

We saw strength pretty much across the board in all areas of this business unit in both the US and Mexico. In our investor and consumer unit, all of our major commodity groups showed revenue gains expect for appliances. But the main driver here was very strong performance in our metals and scrap business particularly in Mexico, this strength is continuing into the first few weeks of 2013.

For Ag and minerals, the headline story as you all know is the several drought in the United States last year. Our grain franchise is very strong but there were simply not enough corn which is our main commodity group to go around. We are also negatively impacted by the loss of a large cross boarder corn syrup move during the year due to a plant relocation in Mexico. And finally our rock shipments particularly into the Haynesville Shale area were down due to lower drilling activity in that region. Going forward, we are optimistic about this business and the Ag and minerals group in for reasons that I will cover in my outlook comments little later.

Revenues in our energy business were basically flat in spite of a 20% reduction in utility coal which represents about two thirds of the revenues in this business unit. RPU gains were a function of mix specifically strength in longer haul utility coal moves and growth and revenue per unit business like crude oil and frac sand which typically have had a higher RPU and I'll talk more about that in a couple of slides.

Our intermodal business was strong but a little weaker than you’re used to seeing in previous quarters. Cross border growth continued in the double digits, I will show you that in a couple of minutes and for the first time ever (inaudible) volumes were lower than the previous year due to some factors again that I will cover little bit later. For the full year, our intermodal volumes and revenues were up 14% and 22% respectively.

And finally our automotive business continues to perform extremely well. Revenues and volumes were record levels for the 9th consecutive quarter which is really remarkable given the normal seasonality in this business. I think this is clear evidence of the strengthening role of Mexico as a player in the global auto business. RPU in this business did benefit from the strengthening of the Peso. FX added about 6% to the gain and revenue per unit.

Moving onto slide 17, again in spite of lower volumes and utility coal and cross border grain we saw slight revenue increased due to volume. Fuel surcharge revenues increased by about 15% over last year. The main driver in the rate mix other category was in our energy business which was a function as I said earlier of longer length of haul and growth in higher RPU businesses like crude oil and frac sand.

Foreign exchange finally posted a gain for the first time this year. We had a pickup due to the strengthening of the Peso. As we have explained before and as you will hear from Mike Upchurch in a few minutes, this gain was almost completely offset by higher Peso denominated cost so the impact on operating income was essentially flat.

Slide 18 shows the moving pieces of our energy business and as you can see from this graph, growth in our crude oil and frac sand businesses almost completely offset declines in utility coal revenues. This was also the case for the full year. For all of 2012, our utility coal revenues fell by about $35 million and crude oil and frac sand combined grew by about 32 million.

For the fourth quarter crude oil and frac sand revenues grew by 780% and 35% respectively from the fourth quarter of last year. I'll show you more on that in a few slides.

Moving on to slide 19, cross border revenues were 2% higher than the fourth quarter of 2011 and we have seen a declining trend over the course of 2012 which is entirely driven by Ag and minerals particularly grain and corn syrup.

Cross border revenues in our Ag and minerals business were at the lowest level since the third quarter of 2010, which as you all will recall was impacted by hurricane Alex flooding in Mexico. Excluding the impact of grain, our cross border revenue would have been 22% higher than the fourth quarter of 2011. We had all time record cross boarder revenues in our industrial and consumer intermodal and automotive business. Assuming that we have a descent corn crop this year, we should see strong comps in the second half of 2013.

Moving on to slide 20, cross-border intermodal growth continues in the high double digits, as you can see with volume and revenue up by 74% and 70% respectively. This was another quarterly record for our cross border intermodal business.

For the full year, our cross border volumes increased by 88% to about 49,000 loads. You will remember that we estimate the size of the cross border truck market to be somewhere between 2.5 million and 3 million units and growing so you can see there is still a lot of room for growth for us in this area.

And now I will spend a little bit more time talking about Lazaro Cardenas and what we believe occurred in the fourth quarter. Before I do that, let me just say that the long-term growth outlook for Lazaro Cardenas continues to be very positive. On the next slide, I will remind you about some of things taking place at Lazaro that will substantiate our long-term growth outlook.

Now, back to the quarter, for the first time ever, we saw a reduction in year-over-year container volumes at Lazaro Cardenas even though revenues increased by 12%. We believe this was driven was a few factors. First and this is hard to quantify, the peak season in 2012 was shorter and more heavily concentrated in the third quarter than we saw last year. I think you saw this in the US as well as retailers were willing to shrink inventories heading into the Christmas season.

Second, there were some re-routing of empties to the port of (inaudible) as a couple of our ocean carrier customers were managing vessel loading capacity differently. This would also explain the large increase in RPU as empties moved at the lower rate than loads.

Third, in the fourth quarter of 2011, we had a surge in shipments of aluminum that was not recurring in 2012 and finally this quarter was particularly tough comp as the fourth quarter of 2011, we showed volume growth of 32% and revenue growth of 35. So it was a particularly strong quarter.

Last year there was a temporary shift in movements to Lazaro during the fourth quarter due to a hurricane that hit Manzanillo area in 2011. For the full year, container volumes and revenues at Lazaro grew by 12% and 22% respectively, still very solid increases particularly given that 2012 is the fifth consecutive year of exceptional growth rates at Lazaro.

A number of our ocean carrier customers have told us that they expect to see double digit growth in volumes in 2013. So we believe this reduction in volume is a temporary phenomenon driven by a few isolated factors and in no way an indicator of future trends at Lazaro Cardenas. In fact, if you turn to slide 22, we’ll remind you of some of the growth projects currently taking place. And you can see on this page the recent announcements APM Terminals signed a second containers concession contract in August of this year for terminal that we believe will open in late 2014 or early 2015.

If you look at the middle picture on the slide, you can see the area just above the current facility is the location of the APM terminal. They have told us that they expect volume once this facility is fully built out to be able to handle 2.5 to 3 million containers.

Secondly, in October of the last year, SSA Marine won a concession to develop and operate a new specialized auto terminal which we’ll be to handle 750,000 autos a year, finished vehicles a year which is more than double the capacity at the current facility.

And finally Hutchinson Port Holdings plans to have five new vessels cranes installed in the second quarter of 2013 which will also result in a significant capacity expansion. So, put all of this together and you can see why we feel that the outlook for Lazaro Cardenas is very positive over the long term.

Turning now to slide 23, we show you the market outlook for 2013 across our entire portfolio. Dave told you earlier that our view of 2013 is for high single digit revenue gains driven by mid-single digit increases in both volume and pricing. As you can see from this chart, we feel good about the outlook for all of our major business units for the coming year.

I’ll just touch quickly on some of the key drivers. First of all you’ll notice that this for full year guidance. So, the views expressed here could be different for any given quarter and obviously, the health of the economy, weather and other factors outside of our control will impact our outlook over the course of the year.

In chemical and petroleum we are expecting Mexico to be a little stronger than the US, particularly regarding petroleum shipments. Industrial and consumer, as I mentioned earlier, that we had particularly strong growth in metals and scrap during the fourth quarter. That is continuing in the first few weeks of 2013 and we expect that to continue to throughout the year. We are also looking for growth in paper and appliances as well.

The one that may surprise you is Ag and minerals where we are looking for single-digit improvement even though we are off to a weak start in 2013. Assuming that we have a decent corn crop this year, the comps in the second half of 2013 should be very strong. In addition you will remember that in the third quarter presentation we featured two new grain shuttle loading facilities that are currently being built on the KCS network and will be up and running for this year's harvest. Don't expect to see strong comps in the first half of the year, particularly in the first quarter, but for the full year we feel that we will finish above 2012.

Another possible surprise is energy, given that our utility coal business is also off to a pretty slow start. Based on the 2013 nominations that we have received from our customers, our utility coal business will be down in the mid-single digit range, but the comps will not be as bad as last year. And as we began to see in 2012, the new energy business in frac sand and crude oil will more than offset the weakness and this unit as a whole will show growth this year.

Our growth rates in these new markets will likely begin to decline but they are still very high and these will continue to become a larger and larger slice of the energy business unit. Just from 2011 to 2012 due to the combination of shrinking coal revenues and growth in the emerging markets, our utility coal business fell from 87% of this business unit revenue to about 70% in 2012.

I think our intermodal and automotive business units are pretty well understood. As Dave mentioned earlier, even though we still consider 2013 to be a bridge year to the four new auto plants being constructed in Mexico, we expect our automotive business to grow in the double-digit range.

Moving on to slide 24, last quarter, we introduced this chart that shows the primary long-term growth drivers in our business, and the punch line that these areas now represent almost a fifth of our total business and they are growing at a very high rate. In the fourth quarter of 2012, these businesses combined grew by 39% over last year.

Crude oil, which is still a very low base, was the fastest growing by 780% over last year. For the full year, crude oil grew by about 350%. Frac sand growth was at 35% for the quarter and 60% for the full year as we did see some seasonal slowing and drilling activity into the holidays. Automotive growth was at 33% for the quarter and 25% for the full year and we describe that as a bridge year as well. The new plants in Mexico are coming online beginning in the first quarter of next year 2014 and we are expecting a noticeable surge in volumes as production at those facilities ramps up. And remember that those plants as well as expansion at existing plants will result in an increase in Mexican finished vehicle production by about 25% to 30% from last year's levels. So, it's really these areas that are the key themes of our long-term growth story and we continue to feel very good about each of these areas of opportunities.

Finally, I'll close my comments on slide 25. Dave and I have covered most of these points already, so I'll just reiterate the conclusion. We feel that 2013 is going to be a very good year for KCS. Assuming the economies in the US and Mexico perform in a manner consistent with the consensus view, roughly 2.5% growth in the US, 3.5% growth in Mexico and we have a decent corn crop and the utility coal business doesn't weaken significantly, we are expecting revenue growth in the high single digit range and volume and pricing both in the mid-single digit range.

Our new business pipeline is robust. Our long-term growth drivers are generating exceptional growth, so we feel that the KCS long-term growth story is very much intact.

With that, I'll turn the presentation over Mike Upchurch.

Mike Upchurch

Thanks Pat and good morning everyone. I'm going to start my comments on slide 27 as we've already indicated fourth quarter revenues grew 7% on carload growth of 2% and revenue per unit growth of 5%. Operating expenses increased 4%, contributing to operating income growth of 15% and our incremental margin in the quarter was approximately 60%. Other notable trends are highlighted in this condensed income statement. I'll comment on a couple of those items.

Interest expense declined 24% to $23.8 million in the quarter resulting from refinancing activities and debt retirement. Our debt retirement costs declined significantly from the fourth quarter in 2011 as that was the quarter we retired our 13% notes with cash. Income tax expense was 57.8 million in the fourth quarter 2012 versus 700,000 in the fourth quarter of 2011 and is the result of improving taxable income, but most importantly an improving peso that I will discuss in more detail in a few slides.

So strong performance across the board contributed to 19% growth in adjusted EPS to $0.92 from $0.77 a year ago and as Dave mentioned, we have revised our definition of adjusted EPS to exclude the impact of foreign exchange fluctuations and I'll provide a little bit more detail on that in a couple of slides.

Turning to the full year of 2012 on slide 28, we have solid revenue growth of 7% coupled with strong expense controls that led to operating income increase to $716 million for the year. Adjusted operating income grew 15% year-over-year.

Other key highlights in the condensed income statement for our full year included $29 million reduction in interest expense, again from refinancings and debt reductions. Our debt retirement costs were 21.1 million down from 36.5 million in 2011, and our effective tax rate was 38.4% significantly higher than the 27.1% rate in 2011. And again is largely due to currency impacts from a peso that strengthened from 14 to 13. Adjusted EPS improved 23% to $3.56.

On slide 29. As I mentioned a few minutes ago, we did change our definition of adjusted EPS to exclude the effects of foreign currency during the quarter. So, in other words, if FX had remained constant during the quarter, we would not have had any foreign exchange gain or loss nor would we have experienced any kind of tax rate volatility from revaluing our US dollar debt. I'd refer you to our website for further details on the reconciliation from reported diluted EPS to adjusted diluted EPS, but in this slide, you can see our fourth quarter 2011 adjusted EPS was $0.77. Increases in operating income contributed $0.13 to our increase and decreased interest expense contributed another $0.04 to our overall adjusted EPS increase. So for the quarter we were at $0.92.

Turning to slide 30. This reconciles the statutory tax rate to our effective tax rate for the fourth quarter. As you can see the fourth quarter of 2012, highlighted in red, our foreign exchange impact increased our effective rate by 4.9% and is the result of the exchange rate improving from 14 at the end of 2011 to 13 at the end of 2012.

And again, this represents the tax impact of revaluing our US dollar debt that we have in Mexico based on changes in the exchange rate as the strengthening peso creates taxable income thus driving up our effective tax rate which you can again see was the case for fourth quarter of 2012 with the 4.9% increase.

You can also see we experienced the exact opposite effect in 2011. We experienced a 28.6% reduction to our tax rate from a weakening peso from 2010 to 2011.

And for the full year on slide 31, our effective tax rate was 38.4% versus 27.1% in 2011. And again in the chart if you focus on the red blocks, you can see the variances really entirely due to foreign currency impacts and as we begin transitioning to a cash tax payer this year in both the US and Mexico, we will begin exploring alternatives to potentially hedge the risk of cash taxes increasing due to foreign currency.

For 2013, to give you a little bit of guidance, assuming a constant exchange rate of 13 that we had at the end of 2012, we would expect our full year tax rate to be approximately 35%.

Now turning to slide 32, our fourth quarter operating expenses increased 4% over 2011, and as you can see in the table on the right side of the slide, fuel price negatively impacted our expenses by 6 million. I'll talk a little bit more about fuel in a couple of pages. An improved peso negatively impacted expenses by 5 million offsetting the $5 million increase to revenues that Pat described on slide 17.

Depreciation increased nearly 5 million from higher capital base and to give you a little bit of guidance on 2013 depreciation expense, we expect depreciation expense to be approximately 215 million for the full year of 2013. And despite higher carloads volumes, we were able to manage other expenses to flat on a year-over-year basis.

Now I'd like to cover a few of the detailed expense line items in the next few pages. Beginning on slide 33, you can see our comp and benefits expense actually decline by $3 million year-over-year. That was largely due to lower incentives which was offset by increases in wage inflation and the strengthening peso.

In the graph you can see headcount continued to decline year-over-year as our operations team has done a great job managing headcount and cost by absorbing volume increases through a number of productivity initiatives.

Incentives declined by 7 million and that was largely a function of the timing of this incentive accruals in the fourth quarter of 2011 that required a year-to-date true-up for higher earned tiers as we exited the year 2011.

On the next slide on page 34, fuel expense increased $6 million, largely price driven as our average cost per gallon increased from $2.75 to $2.99. For the quarter, we did have a small fuel lag benefit of about $1 million. This represented a benefit in the US, but actually a negative lag impact in Mexico as fuel prices increased 16% as Mexico fuel prices continued to increase to market levels. Our average price per gallon was 3.24 in the US which was a 4% increase over 2011, while in Mexico our price per gallon was 2.73. FX headwinds were offset by fewer gallons consumed primarily as a result of the traffic mix.

On slide 35, materials and other increase 7 million year-over-year. It was really the result of two items; you can see concession fees went up $3 million year-over-year. We’ve previously reported that our concession fee payment increased mid-year 2012 from 75 basis points to 125 basis points and that caused a $3 million quarterly increase year-over-year. And my comment is, as we move forward into 2013, we would expect a bit of a headwind there with about a $10 million increase in our concession fee payments year-over-year.

Also, our casualty expense increased 3 million and that was a result from lower personnel injury, actuarial adjustments that we recorded fourth quarter of this year versus fourth quarter a year ago.

And now, I would like to wrap up my comments on slide 36. We generated 35 million of free cash flow for the year, and just as a reminder, our free cash flow number includes cash from operations, less investments and dividend payments, and the reconciliation of our free cash flow can be found on page 12 of our consolidated investor report on our website.

But again, consistent with our prior reports, our primary objective with cash flow continues to be investing in our business to help support the growth opportunity in front of us, and as Dave shared with you, we will be continuing to invest in 2013 at levels similar to low 20% to revenue range we saw in 2012. It is a good indicator or our financial strength. We did pay approximately 70 million in cash for 30 locomotives that we took delivery in the fourth quarter.

From a capital structure prospective, we continue to make progress to improve our credit profile as we renegotiated and amended our credit facilities during the quarter and did achieve investment grade status in the US from Moody's. We continued to believe we're close to achieving the remaining investment grade ratings required to refinance some of our KCSM debt which would provide us the benefit of further lowering our interest costs and extending maturities.

Looking ahead, we would fully expect to exercise our April 1 call right on the 12.5% note and either refinance those or use cash to retire them. Additionally, dependent on upgrades to our investment grade rating, our $300 million 8% notes in Mexico may also be attractive to refinance. At a minimum interest expense should continue to decline roughly 10% to 20% from 2012 levels which is all dependent on the timing of investment grade upgrades and market conditions.

And finally, our Board or Directors approved our fourth quarter dividend on November 15 of 2012 which we did pay before year end 2012.

And with that, I'd like to turn the call back over to Dave.

David Starling

Okay, thanks Mike. In closing, we continue to demonstrate solid operating metrics, consistent cost control and as Pat stated solid revenue growth. So with that, I'll open it up for question-and-answers.

Question-and-Answer Session

Operator

Thank you, we will now be conducting the question-and-answer session. (Operator Instructions). Our first question comes from the line of William Greene of Morgan Stanley. Please proceed with your question.

William Greene - Morgan Stanley

Dave I know you mentioned that you don't want to give too many specifics around the 2013 operating ratio. You had some very good incrementals though in the fourth quarter despite the slowdown in traffic growth. So I was hoping maybe you could add a little bit of color maybe hardening back to some of the comments you made in the past about kind of 1 to 1.50 in terms of improvement in the operating ratio.

As you get better, I don't know when we should think about this topping out the productivity storage have been going on a long time. So, can you add any color here about the incrementals about the margin sort of over the next few years just where it can actually get to?

David Starling

Well William as we've stated in the past, we still have opportunities. We have a contract that will expire actually in first quarter that we are going to probably go from contracting out to bringing it in-house. We've got one other major contract we're looking at in Mexico on maintenance. So, we still have opportunities. We're still able to do creative things on (inaudible) locomotives in Mexico which we had not been able to do in the past. We're now running those locomotives through. So, we still got a lot of opportunities. No doubt with the 12 point reduction we've had over the last few years, you would think we've taken out all the low-hanging fruit, but there are still opportunities there. And with the team we have in place we will continue to lower the operating ratio.

Our main goal is to remain fluid, to spend enough capital that we're onboarding all of this volume and revenue without any service deterioration. But we will continue to improve and it will be a combination of cost control and revenue growth. But at this point, I think we are better just to tell you we are going to continue to improve rather than set an arbitrary target out there.

William Greene - Morgan Stanley

And then maybe you can offer some comments and Mike feel free to weigh in, just in terms of the CapEx number, where should we think about this normalizing and when sort of would it normalize? It sort of feels like the revenue story is very good but does require a pretty heavy CapEx budget, maybe just some comments there.

David Starling

Well, we are at 515 for 2013. To us, that’s not a big number. Again, we are a growth railroad and the worst thing that this team wants to be accused of is having some service deterioration because we didn’t have the foresight to spend the money required to onboard the business. The automotive business is very service sensitive. Some of that business actually carries penalties when you have failures.

So we are going to make sure our system is fluid and when you are looking at a franchise that’s been around 125 years and you are making capacity investments, I don’t know when those become bad investments. I mean, we are going to be around for a long time. If you look at the growth projected by the AAR and others, railroad volume is going to grow up tremendously over the next 30 years. So, I don’t know when capacity becomes a bad investment.

Mike Upchurch

Phil, this is Mike. And just two comments and Dave Ebbrecht provided a little bit of guidance on where we are spending money in 2013, but remember, our intermodal growth and our automotive growth, we are not going to lose that opportunity to continue to capture well above market growth and it does require some investments in our intermodal facilities and certainly on the equipment side in some Automaxs and we’re going to make the right investments to make sure we get that growth.

David Starling

I might add one other thing. We talked in the past about 80% lease and 20% ownership. We are trying to change that model over time. We certainly see some OR improvements and more ownership and less leasing. So, just like the locomotives that we purchased this year or in 2012. In the past we would have leased those locomotives. This time we paid cash on. It requires capital, but we think that's the right decision to make.

Operator

Our next question comes from the line of Allison Landry of Credit Suisse Group. Please proceed with your question.

Allison Landry - Credit Suisse

Wanted to ask you guys a little bit about the guidance for 2013, and do you think you are being on the conservative side with regards to your mid-single digit volume expectations? You know it seems that with the new opportunities coming online specifically towards the back half of the year that you might see some things towards the higher single digit range and maybe that would push revenues to the low double digits. So, I was wondering if you could comment on which businesses you might be erring on this side of caution.

David Starling

I'll take a quick shot at it and turn it over to the expert here, but, if you can tell me what the weather is going to be in Iowa up in the corn belt which has had the worst drought that this railroad can remember and you can tell me what's going to happen with coal, then I will give you a better answer. Are we being a little conservative? There are some unknowns out there. Are we nervous about the economy and what's going to happen with the fiscal cliff? Of course we are. So far it's not reflecting in our numbers, as the negative customers still feel good about 2013, but are there some opportunities for higher growth rate, absolutely.

Dave Ebbrecht

I would just pick up. It wouldn't take much to move that across the double-digit line, but just again some of the things that Dave mentioned, the uncertainty, the difficulty we've had in forecasting coal and grain in particular, we felt that we would maybe mute those projections a little bit in those businesses.

Allison Landry - Credit Suisse

Then just a follow-up question on the crude opportunity. There's obviously a lot of pipeline capacity coming online in the Bakken and the Gulf Coast. So, I was wondering if you could talk about your growth expectations for the crude by rail business, maybe within the context of changing supply flows and growing demands in the Gulf for heavy Canadian crude.

Patrick Ottensmeyer

I guess I'd start by saying don't expect 780% growth. That was remarkable, but it's a small base. But what we're seeing is, and what we feel good about long-term is our position in Port Arthur, Texas. Port Arthur is one of the largest refining markets in the world, some of the largest refineries in the world located there. It imports over one million barrels a day. The customers there like the heavy and the sweet. So, we are moving Canadian and Bakken and West Texas. There's just a lot of activity and really getting back to your first question Allison, this is one of the areas that's very difficult for us to forecast because business is coming at us from places that we are not even looking for it to be honest with you. But we think crude by rail in spite of what happens with the pipelines, crude by rail we believe is going to be around for a long time, because the customers seem to like it. It gives them flexibility. It doesn't require the kind of long-term rock solid take or pay commitments that the pipelines require to be built and financed. So, we think this is a business that's going to grow fast for the foreseeable future and be around for a while.

Operator

Thank you. Our next question comes from the line of Chris Wetherbee of Citigroup. Please proceed with your question.

Chris Wetherbee - Citigroup

Maybe a question first just on headcount and capacity of the network as you think about the CapEx that you've outlined for 2013 and then kind of the leverage you've been able to get off of the existing headcount. How do you think about that Dave maybe as far as adding heads as you go through '13? I think you guys have told us in the past how much more volume you feel like you can take on at least in Mexican side of the network without really adding too much from an incremental perspective. I was wondering maybe we could get an update on that.

Dave Ebbrecht

Sure. First of all, we are hiring in the growth areas that we are seeing in specific quarters. But there are other quarters, where we are not seeing as high growth. And so, we're able to transition headcount from one area to an area of need, that's what we’re doing. So, all in all, where we can maintain a flat headcount and continue to run longer trains and leverage our latent capacity, that's what we’re going to continue to do. So, in that light, there will be incremental growth that comes as we see significant growth opportunities in some of our high growth areas. But right now, we've been hiring mostly for attrition purposes and we will continue to scale well below our growth profile.

David Starling

Thank you and I might add to that to Dave won't to compliment himself, so I will. Dave done an excellent job, he and his team in evaluating what's happened with the grain crop in the back half of the year and also looking at the next two quarters. We know that there's not going to be a big grain crop until there is planting and harvest. So there's no reason to add that incremental headcount now until you know the harvest is coming in the fall and then you bring on the headcount, get them the train, get them ready. So, they've been very, very good at waiting until the timing they need headcount rather than bring them on early.

Chris Wetherbee - Citigroup

Okay, that certainly makes sense. It sounds like flattish for now and we'll see kind of how the business progresses in the back half. I guess maybe, Pat one of you, just on the intermodal side when you think about Lazaro, I just want to make sure I kind of understand how the market is kind of playing out there? I guess, is there any concern that with APM opening up a terminal in the new few years that there could be some repositioning of some of their volumes and obviously Maersk has been a big customer of Lazaro for many years, any repositioning of their volumes until that terminal opens up. I guess I just want to understand maybe how the timing there and the relationships between there. There are several parties that are operating in that region kind of look at this point?

Pat Ottensmeyer

I don't know what you mean by repositioning. I don't think there will be any activity, and of course the Hutchinson as I said is starting to ramp up. They are going to go from five vessel cranes currently to 11 by the end of the second quarter. So, I think what's happening is, they see that the APM facility is going to be built. They are doing what they can to protect their market and grow. What we would expect to happen when the APM facility opens is that there would be some shift obviously, Maersk would be one of the obvious. They might move from Hutchinson to APM, but the fact that APM is investing $900 million, Hutch is investing a lot to expand their facility over the next four or five years and we could see capacity go from a about 1.5 million to maybe 5, and I think that's all good.

David Starling

I think what you’ll see is a new port opening. You’ll see more competition at Lazaro. I think you'll see those two, Hutch and APM fighting over business, which will be to the detriment of Manzanillo and you'll see more business coming out of Manzanillo shifting over to these two facilities.

Chris Wetherbee - Citigroup

Okay, more competitive environment there will bring some more volumes down?

David Starling

Correct.

Operator

Thank you. Our next question comes from the line of Thomas Wadewitz of JPMorgan. Please proceed with your question.

Thomas Wadewitz - JPMorgan

I have two questions for you if I can. First just a granular one on the crude by rail. It obviously seems like a really nice store for you guys. How many refineries that you serve can take unit trains at the present time and we're taking business in the fourth quarter and then how many refineries would you expect to have that unit train receiving capability in 2013?

David Starling

There is really only one facility right now that can take a unit train. It's not a refinery. It's actually a terminal. It's a tank farm and logistics terminal. We are delivering crude to other refineries but not in unit train quantities. And then we are still seeing a lot of interest. We talked on the last year or so about this concept of the Port Arthur crude terminal on that 500 acre piece of property that we own. There is still lot of interest in that that would be able to take several trains a day in theory. The property is big enough. It has water access and it has pipeline access and then that facility would be used as a distribution point to the refineries in that area.

Dave Ebbrecht

Let me add one other color on this is that we ship the trains down to the facility area in unit train volumes and then what we'll do is we'll stage a train and then spot them into the receiving tracks, whether it'd be in 25 to 35 car volumes and then quickly put the train back together and maximize the efficiency of the flow of that type of product.

Pat Ottensmeyer

We can’t use generally don't want to build the track and store the cars. So, if we can find other places to do it like the facilities that we have in that area or this crude terminal that we’re still talking about, that would be the way to serve that market.

Thomas Wadewitz - JPMorgan

So, there is one that's running today but you still would hope in the future to get a bigger terminal built there in Port Arthur?

Pat Ottensmeyer

Right.

Thomas Wadewitz - JPMorgan

That’s good and if it's okay for me to come in with a second one here, Pat on the volume you talked about I think mid-single digit for the year, but obviously second half could be stronger than first for a variety of reasons. Any thoughts on how you might split that? Is it low-single-digit first half of the year and then high-single in second? Is it as simple as that or any commentary on how you might compare first with second half?

Pat Ottensmeyer

I think the first quarter, we'll see growth, but I think the growth would probably be lower than what we’re guiding for the full year. Again, the big factor there is grain. You've got to grow the crop before you can have anything to ship. So, our first half comps should be pretty weak in that area. So, I think the way you described it over the course of the year with new facilities and other things coming on, the growth will get stronger as we move on through the year.

Operator

Thank you. Our next question comes from the line of Matt Troy of Susquehanna International Group. Please proceed with your question.

Matthew Troy - Susquehanna International Group

Is Jose still on the line?

Jose Zozaya

Yes, here I am.

Matthew Troy - Susquehanna International Group

If I think about the administrative transition in Mexico, I was just wondering if you could give us an update on how the relationship with the Mexican government is, and as you look out over the next, let`s call it, two to four years, what you see is the biggest opportunities from where you sit in your position down there?

Jose Zozaya

Okay as I mentioned previously, we have a very good relationship with the new administration. I have already had several meetings with the new Secretary of Communications and the new Under Secretary of Communications with from the Reporting Investment for Promoting Agency for Mexico and with other secretaries of the state, like Secretary of Economy, also have the opportunity to (inaudible) and we are about to have a meeting, a private meeting with our CEO in Mexico City also with the President. We have a very outstanding relationship with them.

Matthew Troy - Susquehanna International Group

Excellent and in terms of just the opportunity, do you see things perhaps falling your way or just that might unfold, let's call it the next two to three years, what gets you most excited down there?

Jose Zozaya

Well as we see and has been already mentioned here, manufacturing is growing in Mexico and the new administration has dedicated a lot of resources in that area. Also too much higher investment in infrastructure. They already mentioned and committed to put more budget on rail and also for infrastructure in Mexico. And the new administration is working in changing the as you already know, all related to energy, the regulation on energy to promote private investment in energy that would also make huge change on Mexican economy.

Matthew Troy - Susquehanna International Group

I know tactically you’ve outlined some of the plans for capital deployment and debt retirement in 2013. I was wondering if you could just put maybe directionally the big pieces together. A shift to investment grade, obviously an opportunity on some of the US dollar denominated debt in Mexico. What are we talking about in terms of round numbers, big picture? If you were to get that, basically clear that hurdle, how much debt and what would be the percent interest rate potential savings, talking big picture long-term?

Mike Upchurch

We haven't made any firm decisions and as you indicated in that question, it's somewhat dependent on the timing of upgrades from the agencies. But as I mentioned, the two issues that we have out there are the 12.5% notes in Mexico, that's about 100 million and then an 8% note in Mexico that's about 300 million outstanding. That 400 million would be our prime candidate sitting here today. If we were to refinance all of that debt, you're looking at in today's environment roughly you know 4%. So you can do the math on that and I did try to give you a little bit of guidance of down anywhere from 10 to 20% in interest expense off of 2012 levels, which was 100 million. So that would imply a $10 to $20 million potential interest rate expense decline this year.

Operator

Thank you. Our next question comes from the line of Brandon Oglenski of Barclays. Please proceed with your question.

Brandon Oglenski - Barclays Capital

I just wanted to come back to the opening question and talk a little bit more about the operating ratio. If I look at your guidance for 2013 with revenue growth potentially eclipsing the pace that you had this year or last year, shouldn't we be thinking that we could see operating ratio improvement similar to what you did in 2012 or are there some cost items moving around that maybe we're not thinking about fully?

David Starling

I'm sure the potential is there if we get the revenue that we need built into the plan and there’s potential there for an excellent year.

Mike Upchurch

I did give you a couple of tidbits on depreciation expense going up roughly 15 million year-over-year. I also indicated that concession payment would be up about 10 million year-over-year. So, we have a couple of cost headwinds there, but we feel very confident about where we can continue to improve margins.

Brandon Oglenski - Barclays Capital

Okay and maybe this one is for Pat, but with your cross border intermodal growth pretty significant last year, are there any new carrier contracts that you have singing up this year, that you are in negotiations with that give you confidence we are going to continue to see those pretty strong growth rates?

Pat Ottensmeyer

Not really from a contract side, but I would say just generally, the level of engagement that we are seeing from our partners and the fact that they are experiencing good growth and the market is big and they all see the opportunity. So I think as long as we continue to do our part which is to improve the service and frequency and invest in the facilities, there is absolutely no reason that we can’t see very high growth rates in the markets there. The networks in place, our partners are engaged and it’s happening.

Operator

Thank you, the next question comes from the line of Ken Hoexter of Bank of America Merrill Lynch. Please proceed with your question.

Ken Hoexter - Bank of America Merrill Lynch

Appreciate the detailed run through pat but can you talk about the status of one of your largest coal customers? I know they shut down, what two boilers during the last month. Can you talk about what’s included in that? I think you mentioned down 5% in terms of your utility demand. What do you think that that customer will do on their other plant? Do you think you have further shutdowns? I am just trying to get a view on that and then same thing on grain. When you talk about that, can you talk about what's left in storage in terms of what volumes you think can be moved in the first half of the year before the crop get started?

Pat Ottensmeyer

And first on coal, our forecast is based on fairly fresh projections and nominations and expectations that we've gotten from all of our customers. And of course we learned last year those can be wrong and those can change over the course of the year. So there are still factors out there that could cause that to change as we move on the year like weather and gas prices that that we are not expecting. We haven't been informed of any additional plant closures. The one large customer is still taking coal, but they have shut down two of the three units at that one plant. Their plan is to bring that back up in the spring for the summer, and so their forecast is based on that assumption. But our coal business as I mentioned for just utility goal, we're expecting a decline in the mid-single digits over the course of the year which is better than last year, year-over-year comps, but still down.

Grain, there just really isn't much. We read a lot and there is a lot of buzz out there about Mississippi river diversion. That's really not the factor for us, because we don't originate grain off the river or in those areas. We're beginning to get more out of the upper Midwest, Minnesota, North Dakota which could help a little bit here in the first and second quarter, but it takes a year to grow our crops, so until we get a new crop in, our grain business is not going to be very strong.

Ken Hoexter - Bank of America Merrill Lynch

Mike if I can have my follow-up on the tax rate, it sounds like a lot of changes to get the new adjusted EPS on a regular basis and I appreciate that. But you mentioned a 35% tax rate. Has anything else changed that flows in with that? Are there costs somewhere else that keep that at a lower tax rate than the 40%, 41% we've been running through or is that just a new run rate that we should look for?

Mike Upchurch

No, I think if you look at those slides, I mean, we tried to reconcile a statutory rate and you do get some benefit with lower tax rate in Mexico, but we're just trying to isolate that FX impact and make this hopefully a little bit simpler to track in the future and absent FX changes we think our view is 35% for 2013.

Operator

Thank you. Our next question come from the line of Scott Group of Wolfe Trahan & Co. Please proceed with your question.

Scott Group - Wolfe Trahan & Co.

First a couple of things for Mike Upchurch. In terms of, I think I heard about a labor contract that you may insource in Mexico this year. Any way to think about the potential savings there and then just to follow up on that last question on the tax rate is the 35% year-over-year what the effective tax rate will be or the adjusted and then what's your view of the cash tax rate that's starting this year for the company?

Mike Upchurch

35 is what we expected to be for the full year and we have not guided to any kind of cash tax rate. I think you can expect that to be lower. The way I've typically addressed that is, the industry is somewhere between 20 and 25%, but it's a little bit challenging to project and this will be the first year that we're really a cash tax payer, so there can be a lot of movement in that number. So we’ll just leave it at that. On labor side, maybe have Dave comment on it, but we just aren’t going to talk about any specific numbers on that particular contract other than we wouldn’t have done it had it not been a savings to the company.

David Starling

I’ll just add that we’re still in negotiations and this would not be a good time to talk about numbers.

Scott Group - Wolfe Trahan & Co.

But similar magnitudes to some of the contracts that have rolled over in Mexico that you’ve talked about in the past?

David Starling

As I’ve said Scott, we are still in negotiations. This would not be a good time to talk about the numbers.

Scott Group - Wolfe Trahan & Co.

Fair enough and then just thing for Pat on the intermodal side. So I understand some of the comp issues you are talking about with peak season at Lazaro. It feels like those volumes haven’t really moved up yet even though we are through peak. Would you think that the timing is that we kind of stay soft in first quarter and then reaccelerate as those new trains come on at Lazaro or I guess what’s the visibility to getting back to double digit intermodal growth I guess is the crux of the question on the volumes.

Pat Ottensmeyer

At Lazaro?

Scott Group - Wolfe Trahan & Co.

I guess overall for intermodal. We’ve been at a 15% plus run rate for a while now. Do you think we can get back to that run rate anytime soon?

Pat Ottensmeyer

Yes. Lazaro is already coming back. The Lazaro business is up probably not 15% but it’s up over the fourth quarter so far in January.

Operator

Thank you. Our next question comes from the line of Doug Karson of Bank of America Merrill Lynch.

Doug Karson - Bank of America Merrill Lynch

I guess question on the auto side and those four plants going online, there’s expansion across really all of Mexico. Do you have the capacity right now to satisfy all that demand and how do you think the margins will be as we kind of go out into the next year with this kind of ever increasing growth?

Dave Ebbrecht

Capacity, yes, we're doing things now more on the equipment side than on track capacity, but we're doing things now to make sure that we got the capacity before those plants open, and I think we'll be ready. And on the margin side, they are good. Automotive businesses is good and in each of these cases, we'll have opportunities, I think we'll get certainly our fair share of the ramp up in production. But you could see longer length of haul and better margins because this business will be available for us to move on a cross border rather than just within Mexico to move to some of our gateways like St. Louis and Meridian and Kansas City and that should improve the margins.

Doug Karson - Bank of America Merrill Lynch

I guess turning to balance sheet. I've been covering you guys on the fixed-income side for a while and the credit ratios get better and other agencies have had a favorable opinion on you. Do you have an idea what your long-term leverage targets would be, I mean it should already be locked to the investment grade range, just kind of curious of how you want to operate the balance sheet long-term?

David Starling

Could we put you on the credit (inaudible) rating agency? Would you talk to Moody’s? All our metrics are already investment grade.

Mike Upchurch

Well we continue to fight that battle of concerns around fiscal cliff and whether that could potentially by kicking the can down the road on the spending, put us back into a recession. But we did some upcoming meetings that we're optimistic we'll continue to make some improvement there. You're right. Our metrics are well above the requirements for investment grade. You look at our leverage ratio down in the low 2s and the targets by one of the agencies that we're waiting on upgrades is below three. So, all the other credit metrics are very solid and achieved there, our numbers and our expectation is it's just a matter of time and hopefully here in the near term.

Doug Karson - Bank of America Merrill Lynch

You're talking about your various new energy opportunities which offset the decline in coal. Can you just give me a little more color on where you see 2013 on the new energy front?

David Starling

It will grow. As I said earlier, don't expect 780% growth in crude oil every quarter and it is difficult to forecast because business is coming at us from places that we're not even necessarily looking for it. But I think our outlook is that the growth in those areas will more than offset any weakness that we're going to see in the utility coal business. Long-term, I think that's going to continue to be the case. We're well positioned not just in crude oil, with our position in Port Arthur, that our position in West Texas out in the Eagle Ford area, Permian Basin. There's just a lot of drilling activity out there and that's driving our frac sand business and we see that continuing in 2013 and beyond.

Operator

Thank you. Our next question comes from the line of Jeff Kauffman of Sterne, Agee. Please proceed with your question.

Unidentified Analyst

(Inaudible) on for Jeff. Just a quick question, if I look at the RPU on crude oil that almost doubled year-over-year, how do we think about that in terms of how much of that is core price and how much was increasing length of haul?

Dave Ebbrecht

Most of it is length of haul. We had some both in frac sand and in crude oil, we had very nice increases in length of haul.

Unidentified Analyst

Okay, do we expect that to start to decelerate in the next few quarters?

Dave Ebbrecht

No, I would expect it to continue sort of in the range that you saw in the fourth quarter.

Unidentified Analyst

Okay and then on the cost side, if I just look at labor cost, I think it was down about 2.2% per employee. If I exclude that $7 million incentive swing, it’s up about 4%. Is that a good run rate to be using going forward over the next few quarters?

Mike Upchurch

Well remember if you do that, you have about 2% impact on FX as well. So excluding FX under your math, it'd be up about 2% and that might be a better range.

Operator

Thank you, our next question comes from line of Keith Shoemaker of Morningstar.

Keith Shoemaker - Morningstar

I noticed on slide 14, you've got some impressive metrics operationally. What I don't think I saw in the presentation, may have missed, was train lengths. Could you comment on year-over-year train length comparisons please?

Dave Ebbrecht

Sure. Our train lengths continued to expand in some areas and as we start up service especially at our Lazaro Cardenas and some other areas in our intermodal and automotive growth, we have some train lengths that aren't so large. So, net-net, we are remaining slightly positive which is a good story as we continue to grow and we expect to see that trend and the law of averages will basically affect this as we begin (inaudible).

Keith Shoemaker - Morningstar

(Inaudible) I think you mentioned increasing use of DP in Mexico is that right?

Dave Ebbrecht

That correct. We will use DP not only through the bridge operation, which before we were taking off local most conventionalize for reasons of operation at the bridge, but we will also continue to used VP and the majority of our manifest and other operations besides just our long call unit trains in Mexico.

Keith Shoemaker - Morningstar

Maybe could you take a step back and explain how probably you use DP system wide on both sides of the border given that's harder for your network, maybe what is addressable targets?

Dave Ebbrecht

Right now, we're using DP at over 95% in the US and we're using it above 80% in Mexico and DP has a lot of advantages besides just train length, it also naturally provides a 5% fuel savings. So, we're looking for additional benefits.

Keith Shoemaker - Morningstar

Sounds like you are most of way there though with these kind of numbers?

Dave Ebbrecht

As we continue to grow though, we continue to look for opportunities to DP in every service line we have.

Operator

Thank you our next question comes from the line of Tyler Brown of Raymond James.

Tyler Brown - Raymond James

Pat, just real quick on the frac sand side, can you maybe breakout your sand business by end market? I mean hopefully by play, but if not, maybe split between dry gas and liquids?

Pat Ottensmeyer

It's mostly liquids, it's mostly Eagle Ford, so that's the main driver.

Tyler Brown - Raymond James

Okay, good and then Mike just real quick if I can comment on cash flow, maybe a different way. I mean you got a lot of moving pieces on the cash tax rate side, but just big picture, do you guys expect to generate free cash flow next year after dividend?

Dave Ebbrecht

Yes.

Tyler Brown - Raymond James

Okay and then is maintenance CapEx, do you have a range there for what that might be?

Dave Ebbrecht

Yes, about 10%.

Tyler Brown - Raymond James

And then Dave just reading your state of the railroad memo, it seems pretty clear you guys are pretty busy I guess on a number of fronts, but really seems to be paying off on productivity I guess in Mexico. But just big picture high level, what are really the next projects to be completed that you think really drives the next kind of step-function in productivity? Is it (inaudible)? Is it (inaudible)? what is it there that might drive the next leg?

Dave Ebbrecht

We have got a lot of different things that could provide productivity increase. Certainly, the (inaudible) terminal improvements are going to quadruple the amount of trains that (inaudible) can process through that complex, but we are also entering into a lot of technology endeavors where we’re going to have real time data to deal with issues. That's going to change a lot of the way which we’re able to manage and deal with issues that we have on our network which is going to create a lot efficiencies going forward, and we'll be implementing those systems throughout 2013 and 2015. Dave's got a big initiative on the bridge crossing as well. We want to make the bridge more efficient. So we've got a nice long range plan on how to get more trains across the bridge.

Operator

Thank you. Our next question comes from the line of Brad Delco of Stephens Inc. Please proceed with your question.

Brad Delco - Stephens Inc.

I'll make it easy I guess for you Dave. If 2013 is a bridge year and you are calling for mid-single digit volume growth which I think many rails would be envious of, what would a bridge year not be in terms of if those projects in '14 came in '13, and what are the limits, i.e., in certain commodities that you are doing business in today in terms of whether it’s the track, whether it's the equipment. You know what actually are the limits that you guys essentially achieving better than kind of that bridge year 5% volume growth this year other than the economy?

David Starling

Well, all of the asset side of it, Brad we’re not concerned about. I mean, locomotive availability is there. Both GE and Progress have slots for new locomotives. We've already got cars ordered. We've got specs for what we are going to need for '14. So, we've got a good plan. The auto companies are committed. They are breaking ground. They are building. I mean it would take some kind of a disaster in the economy that caused auto sales to drop, that might cause someone like Honda or Mazda or somebody to stop production, but that's hard to imagine, because their main problem is they can't make a car in Japan today and sell it in the US and make money. So they've got to go to Mexico. They've got to open plants there. So, I really don't see a lot of risk factors. There's nothing that keeps us awake at night. We are spending most of our time making sure that we've got the network capability and we’re ready to handle the business.

Brad Delco - Stephens Inc.

So if I think about kind of parleying that into expected financial results, 2013 you gave some decent guidance on continued margin improvement, but it seems like with the pipe already being laid in effect for those volumes, if the incremental margin we should expect to see in '14 is probably significantly greater than what we expect to see in '13, is that fair?

David Starling

'14 could be a breakout year for us.

Operator

There are no further questions at this time. Mr. Starling, I would like to turn the call back over to you for any additional or closing comments.

David Starling

Okay, thank you for joining us on the call and we'll talk to you next quarter. Thank you.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, have a wonderful day.

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