Burlington Northern Santa Fe Corp. Q2 2009 Earnings Call Transcript

Burlington Northern Santa Fe Corp. (BNI)

Q2 2009 Earnings Call

July 23, 2009 4:30 pm ET

Executives

Matthew K. Rose – Chairman, President and Chief Executive Officer

John P. Lanigan, Jr. – Executive Vice President and Chief Marketing Officer

Carl R. Ice – Executive Vice President and Chief Operations Officer

Thomas N. Hund – Executive Vice President and Chief Financial Office

Analysts

Thomas Wadewitz – JPMorgan

Ken Hoexter – Merrill Lynch

William Greene – Morgan Stanley.

Edward Wolfe – Wolfe Research

Randy Cousins – BMO Capital Markets

Gary Chase – Barclays Capital

Christopher Ceraso – Credit Suisse

Walter Spracklin – RBC Capital Markets

Matthew Troy – Citigroup

Presentation

Operator

Ladies and Gentlemen thank you for standing by. Welcome to the BNSF Corporation Conference Call hosted by Matt Rose. At the request of your host, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). And as a reminder this conference is being recorded.

I would now like to turn the conference over to BNSF Chairman, President, and Chief Executive Officer, Mr. Matt Rose. Please go ahead, sir.

Matthew K. Rose

Thank you, Kathy. Good afternoon everybody. Welcome to our second quarter financial presentation. With me here in Fort Worth today are Tom Hund, EVP, Chief Financial Officer; Carl Ice, EVP, Chief Operations Officer; and John Lanigan, EVP, Chief Marketing Officer.

Our presentation today is available by webcast. I'll start by directing everyone's attention to our first slide regarding forward-looking statements. Of course this statement basically cautions everyone that this forward-looking information presented here today could be affected by any number of factors, which could cause actual results to differ materially from any forecast information that we provide.

I would also like to mention that we'll be providing non-GAAP measures today in our commentary, and ask that you refer to the Investor Relations page on our website for reconciliation to GAAP. Taking a look at the results for the second quarter, we reported earnings per share of $1.18 compared to an adjusted EPS of $1.31 last year.

Freight revenues were $3.22 billion compared to $4.35 billion last year on lower volumes and fuel surcharges offset by continued pricing increases. John will give you a more detail about the change in revenue as well as report on the results for each of the business units in his review. The 30% decrease in operating expenses was driven by strong cost controls and further productivity improvements decreased unit volumes and a decrease in fuel reflective of the significant decline in oil prices.

Our operating ratio was 75.2% down over 400 basis points on comparable basis to the second quarter of last as a result of the benefits of our variable cost structure and our focus on productivity as well as lower fuel prices.

Now, I'll turn it over to John.

John P. Lanigan, Jr.

Thanks Matt. In the second quarter, we had a 26% decrease in freight revenue. Our units were down 19% with RTMs down 13%. Fuel surcharge was significantly lower due to decreased fuel prices. We experienced a $1.1 billion decrease in revenue due to lower volumes driven by the ongoing recession and reduced fuel surcharges related to materially lower oil prices.

These declines were partially offset by a price increase of 3% measured on a same-store basis, which includes contracts that utilize the RCAF escalator, which was at a negative 21% this quarter. And as we know there is not a consistent price measure among the railroads.

Price was 4% when we removed the fuel component of the RCAF escalator. With our mix of business and current volume trends, along with excess trucking capacity, highlighted by our largest customers recent announcement of a 3% price decline, we expect our pricing to remain similar for the second half of the year.

As we said last quarter, the negative volumes strength, the relative volume strength in coal combined with the weakness in our higher rated segments led to the change in mix. We expect this trend to continue through the end of the year. And finally, second quarter fuel surcharge revenue of $229 million was about $590 million less than last year, largely due to a 47% year-over-year decline in highway diesel fuel price.

Turning to the individual business units, coal revenues were down $27 million or 3% on flat volumes. Revenues were down due to lower fuel surcharge revenues as well as the 21% decrease in RCAF. Volumes were flat driven by favorable comps due to weather impact last May and June, as well as increased third party business this year. Stockpiles are at historically high levels and recently there’s been a modest decline in stockpiles and further stockpile declines will be driven by the remaining cooling season demand and general economic activity.

In our agricultural products business unit, revenues were down 25% on a 19% decline in volumes. Whole grain volumes were down by 26% in the second quarter driven by two key factors. First large global crop production is leading to increase competition for the U.S. mostly in wheat and corn markets.

Second, the global economic slowdown tempered demand for grain and grain products, particularly used for higher protein animal consumption. Grain exports to the Texas Gulf were down 48% and P&W exports were down 29% on lower global demand for wheat and corn. And on the domestic side, grain volume was down 16%, while Mexico volume was down 19%. Grain products volume was down a 11%, about half of that was driven by decreased fertilizer shipments where producers were reluctant to commit to higher production costs in the quarter.

Industrial products revenue was down 34% with a 33% decline in units. All five segments of industrial products continue to experienced negative revenue growth reflecting the broad based recession. Construction products had the largest revenue drop driven by steel and taconite. Lower oil and natural gas prices led to decreased demand for drilling materials, which in turn led to the decrease in minerals and clays.

Building products revenue declined by 35%, primarily due to lumber and panel, which are highly correlated to housing starts. Lumber and panel volumes were down 42% and paper declined by 29%. Chemicals and plastics volumes decreased by 20%. Consumer products saw a 34% decline in revenue on a 23% decline in volume. These results reflect the impact of the U.S. recession highlighted by weaker consumer spending.

Domestic intermodal reported a 30% decline in revenue, on a 15% decrease in units, which correlates with weak domestic over the road trucking trends. International posted 37% lower revenue on a 28% decline in volume, due to the continuing impact of the global recession on trade. And our auto segment saw a 43% decline in revenue on a 44% decline in volume driven by slow U.S. auto sales.

Our weekly volumes in ag, industrial products and consumer products are showing signs of stability, although no significant upturn yet. Here are BNSF’s weekly units for the first half of year. As you can clearly see the declining volume trend in the first quarter is stabilized throughout the second quarter. And now, I'll turn it over to Carl for a review of operations.

Carl R. Ice

Thanks, John. Our ongoing focus continues to include velocity, service, and productivity. As you all know, this year’s planning has an even higher reliance on cost control than usual, but at the same time, we’ve determined to drive service improvements as we make those cost controls. You can see the results of those efforts in our car velocity. We had an all time record of 236 miles per day, which was a 17% increase, compared to the same time last year and 5% better than last quarter’s previous all time record.

This quarter we’ve also showed you our Dwell numbers to highlight the impact of our ongoing terminal process review and improvement which we call best way. During the second quarter, our Dwell Times improved by more 10% to 22.5. A major driver of this was a significant improvement in our on time performance out of the terminals as part of our best way initiative.

With these improvements in velocity and Dwell Time as you would expect our on time performance improved as well. During the second quarter, we achieved an all time record additionally, each of our business segments improved to show quarter-over-quarter improvement and substantial improvement over 2008.

Locomotive velocity also showed positive results, we had a 5% improvement over 2008, and the best locomotive velocity since 2003. As we look at our online inventory you can see that we have a favorable comparison of active inventory to unit volume, continuing to show the fluidity of our network and our velocity improvements.

As we examine people productivity, you can see our workforce was down about 9% of the last year, which was not quite as largest our decline in volume, but the employee counts don’t tell all the story as our hours worked were down a little over 12%, which drove, which occurred from less overtime, which is partly helped the reduction in compensation of employees, which was down about 5%, which Tom will highlight further later.

In fuel efficiency, we had an all time record of 816 gallons all time second quarter record of 860 gross tons miles per gallon. Also this quarter, we thought it would be helpful to show you a graphical view of the changes in our locomotive fleet and our active inventory. You can see since October last year, we’ve continually reduced these resources to make sure we match our resources to volume.

At this point, we have amount about a 1100 locomotives that either are stored or we returned and a little over 41,000 cars. We also adjusted our employees as you know we’ve been in the position that we needed to furlough employees. We were as high as about 32 or 3300 we have started calling some employees back in the June timeframe as our vacation period peaked.

So going forward, we’re convinced we have the right initiatives to continue to drive operational improvements and to have strong cost control.

Thomas N. Hund

Thanks Carl. As Matt already mentioned earnings per in the second quarter was $1.18 as shown in the left side of the slide. The chart on the right reflects the adjustment in 2008 of $0.31 for an environmental charge. So when adjusting for this item, earnings per share in the second quarter was down about 10% over 2008. The continued effective cost controls in the second quarter helped to mitigate the impact of sharply lower volumes.

Second quarter operating income for 2009 was $797 million an after adjusting for the unusual item I just reviewed. This was a decrease of $92 million or 10% from 2008. We did have one unusual favorable revenue item in the quarter of about $20 million related to a favorable coal rate case decision.

Our operating ratio was 75.2% for the second quarter more than 400 basis points lower than the 2008 on an adjusted basis. Operating expense was $2,519 million for the quarter, lower than second quarter by $1,245 million or 33% on a GAAP basis. After adjusting for the unusual item in 2008 this was a decrease of $1,070 million or 30% from 2008. This decline was driven by lower fuel expense resulting from decreased fuel prices, continued productivity improvements and variable costs associated with lower unit volumes.

As you will see on the charts to follow, excluding depreciation, every expense category was down year-over-year with declines ranging from 12% to 38% even without considering the significantly lower fuel prices. Compensation and benefits expense was $824 million, down $127 million or 13% from 2008 and compensation and benefits expense per employee decreased 5% on a 9% decline in headcount. These results were achieved despite a 4% wage increase for our scheduled employees who make up the vast majority of our workforce.

We are going to give you additional color on compensation and benefits this quarter to help you understand the drivers and provide insight on the remainder of the year. Wages and benefits were down $93 million from 2008 despite the 4% wage increase which cost us about $25 million. Also incentive compensation for exempt and scheduled employees was down about $28 million year-over-year primarily due to lower earnings.

Looking forward, a scheduled wage increase to 4.5% on July 1, will cost us about $30 million in each future quarter. And unless volumes and earnings levels change, headcount savings will be similar between the second and third quarter. Incentive compensation will be favorable by about $50 million in the third quarter versus 2008 and after that we will begin comparing the periods that already reflects weaker volumes and significantly reduced employment levels and incentive accruals.

Finally, later in the year results will reflect an earlier completion of our reduced capital program resulting in lower expense credits for capital labor and the normal seasonality of vacations. Purchase service expense was $466 million for the second quarter down $74 million or 14% in 2008. The decrease was due to variable expenses on lower volumes, which led to reduced cost in ramping, drayage and car repair as well as lower spending for professional and other services.

Depreciation expense was $379 million up $30 million or about 9% from last year, as a result of our continuing capital investment. Equipment rents was $196 million for the second quarter down 12% from 2008 due to improved velocity, lower volumes and the return of leased equipment.

Material and other expense of $145 million was down 65% or $265 million from the second quarter of 2008 on a GAAP basis. After adjusting for the environmental charge in 2008, material and other was down $90 million or 38% in 2008. And this decrease was a result of reduced volumes and cost controls along with lower personal injury environmental and casualty costs.

Fuel expense of $509 million was 61% or $782 million lower than the second quarter of 2008. And the average fuel price per gallon including hedge was $1.65 compared to last year second quarter price of $3.51. This chart provides a little more detail on fuel expense. The decrease in expense was primarily the result of lower fuel prices of about $610 million.

Fuel usage was also significantly lower, which reduced fuel costs by about $240 million. Gallons burned were down about 18% year-over-year and as Carl mentioned we had a second quarter record in fuel deficiency. These reductions were partially offset by hedging losses of $45 million this year versus a benefit of $23 million last year.

The final piece of the fuel picture is fuel surcharge. John discussed earlier the overall impact of the change in fuel surcharge. This slide illustrates the impact of the fuel surcharge lag. As you can see rising prices in the first half of 2008 had a negative impact on our earnings and this trends look to a positive impact in the second half of the year as prices fell. When we add up the pieces of the impact of fuel price on expense, hedge and surcharge year-over-year second quarter earnings include about a $0.20 per share benefit or tailwind.

The fuel surcharge lag effect in 2008 was a major component of this tailwind. At current forecasted fuel prices, the net year-over-year impact of lower fuel prices, hedging losses, and fuel surcharges is expected to result in a headwind of about $0.05 per share in the third quarter, and this includes the fuel surcharge lag shown above of about $60 million. Now I’ll also point out the slide above shows the $200 million lag benefit that the fourth quarter of 2008 received.

To sum up, our operating expense discussion, we expect third quarter total operating expenses to be down about 25%. Fuel prices are down significantly and we will continue to keep the pressure on all spending. Interest expense for the second quarter was a $137 million and includes a one-time benefit of $10 million and unwinding the interest rate hedges we talked about last quarter.

Our capital plan for 2009 is $2,600 million unchanged from our previous guidance. Additionally, during the second quarter, we did not repurchase any shares into the share repurchase program as we still believe it is prudent to retain financial flexibility in these uncertain times.

Now, I will turn it back over to Matt.

Matthew K. Rose

Thanks Tom, our second quarter and year-to-date results I think provide further evidence of our ability to manage effectively throughout whatever the economy throws at us. We’re currently in the midst of a historic business slowdown. During this time, I’ve been especially proud of the strong cost control productivity efforts, which resulted in a 13% decrease in operating expenses excluding the benefit of lower fuel prices.

Our customers continue to receive outstanding service. We’ll continue to see prices increase even in these difficult times. The combination of those factors is leading us through this economic cycle.

Now let’s turn to the third quarter. The third and fourth quarters are typically our strongest volume and earnings quarters. However, at this time we are not seeing any significant cyclical increases. As John showed you, volumes have recently stabilized. If volumes stay at these levels we expect EPS for the third quarter to be in the same neighborhood as the first and second quarters. And this is in spite of the modest headwind presented by fuel and the scheduled wage increase.

With the long-term market opportunities in each of our business units and our continued focus on productivity and service, we’re well positioned to benefit as the economy begins to recover.

Kathy, with that I think we are ready to take some questions.

Question-and-Answer session

Operator

Thank you. (Operator Instructions) Our first question is from Tom Wadewitz with JPMorgan. Please go ahead.

Thomas Wadewitz – JPMorgan

Yeah, good afternoon, let see I wanted to – I’ve got a couple of different questions. On the outlook for volumes how far ahead do you think you would actually see from customers and would have visibility to improve in freight? Because I think we’ve heard from most transports that volume have bottomed but the hope of industrial volumes improving, you’re just not seeing it. How far ahead might you see that if it was actually coming?

John P. Lanigan, Jr.

Well, Tom we’ve been having active discussions on a weekly basis with a wide range of our customers. We sample across our customer base frequently right now. We still cannot get customers to give us any headlights on what they think. They’re saying the same things that we’re saying, that they just don’t see it, they’re not sure when and so it’s very difficult at this point to give you an idea of how far in advance.

Thomas Wadewitz – JPMorgan

Okay. Let’s see. On the cost side I think, if the numbers I see here have gotten the model are correct you probably put up the best-cost side performance ex-fuel of the rails that we’ve seen so far. So congratulations on that. Really good job on the cost side. What would it look like in third quarter? Is there any further ranching up of cost side or things you’ve done that that didn’t fully impact the quarter or is this about as good as it gets in terms of year-over-year improvement in cost?

Thomas N. Hund

I’ll start and then Carl or anybody else can jump in I mean, I think we’ll continue to keep the pressure on the cost side. I think those that are truly variable we probably have hit about the normal run rate if volumes stay where they’re, but as I say we’ll continue on all other areas to keep the pressure on. The one thing I will say as we get later in the year, we are going to start to lap or cycle the comps, especially as we get to fourth quarter and we took a lot of cost out in the fourth quarter of last year, everything from starting to reduce the assets and the people employed in our business to incentive comp, to other things like that. So I think third quarter is going to be the last one where we have what I would call the more normal comparison, and that’s going to get a little tougher.

Thomas Wadewitz – JPMorgan

Okay, and then…

Carl R. Ice

Tom, I would just add that we, I think we reacted quickly and strongly and on volume changes. So there’s really nothing that happened late in the quarter that you’d see a ramp up because of that. We’ve had our as Tom said, we’ve had many of our actions in place for months.

Thomas Wadewitz - J.P. Morgan

Right. Okay and one last one, maybe one for Matt, and I’ll hand it off to someone else. We heard your primary western competitor had their call this morning, you’d be at their call this morning and one of the takeaways I had, they sounded a little more optimistic that the message in Washington D.C. is getting through and maybe a little more optimistic that, whatever happens with legislation or if that happens, probably wouldn’t be very damaging. Do you have a similar view, or how are you looking at the potential outcomes on rail legislation right now?

Matthew K. Rose

Well, I think the time that it’s taken is reflective of the quality of the dialogue that’s going on. These bills have been out there forever, and certainly trying to find the right balance of addressing some of the concern of our customers as well as making sure that the railroads remain profitable is where all the action is, and the devil is in the that detail. We do not know what the final bill will look like. So I’m not going to tell you I’m any less concerned about it at all, because it does have the potential to impact our future investments. But when you think about the two transportation bills that have been launched, one in the Senate, one in the house, for the first time ever and I think this is a huge deal for the railroads, for the first time ever we’ve seen both the house and Senate talk about a goal to move gross ton miles off the highway and put them to the railroad. And the only way that’s going to happen is to have a very vibrant railroad industry, and so I think that everybody is asking the question, will any change in regulatory action have a detrimental effect to investment of the rail industry. And as long as everybody keeps asking those series of questions then I think we’ll get to where we need to go.

Thomas Wadewitz - J.P. Morgan

Right. Okay, great. Thank you for the time.

Matthew K. Rose

All right, Tom. Thanks.

Operator

Thank you. We’ll go next to Ken Hoexter with Merrill Lynch.

Matthew K. Rose

Hi, Ken.

Ken Hoexter - Merrill Lynch

Hey, good afternoon, Matt, Tom and team. Matt, I just want to wrap up with what you just kind of ended your call with, in looking at earnings being the same. Did you put parameters around that? I think you threw some things out there. What was it on in terms of what? If volumes are flat, if pricing, if fuel was staying the same and pricing was going somewhere, can you kind of go over what you just built into those targets?

Matthew K. Rose

Yeah I mean, what I said was that as long as we don’t see a big ramp up or big ramp down in volumes, I mean the point is that typically in third and fourth quarters we start to see the volumes really run and we’re just not seeing that right now. But we are seeing a lot of stability in the volume. So what I said was, if volumes stay in the same neighborhood as what we’ve seen, then EPS ought to be a reflective of around that first and second quarter EPS numbers.

Ken Hoexter – Merrill Lynch

All right, great. And then I think John might have mentioned something about pricing. Pure pricing, it was around 4% and something with your largest customer taking a large decrease. Do you see that the pure pricing is now starting to slow? Do we stay at inflation plus? I just want to understand your thoughts on the pricing side there.

John P. Lanigan, Jr.

Well pricing is historically strong Ken, as you know, and what I did say is we think that price will stay in this neighborhood for the balance of the year. So clearly that’s inflation plus pricing.

Matthew K. Rose

And I think Ken, also you have to I mean you have to kind of step back. We have a large part of our business is very truck-centric, which we think is just fine for the long-term and the truckload carriers are all battling for price, and in some cases we’re seeing declines in that sector. And of course we see it firsthand with our relationship with Hunt as well as others. And yet if you look at the numbers that we posted, I think by any stretch of the imagination you’d have to say that pricing remains very firm on the rail side of the business.

Ken Hoexter – Merrill Lynch

All right, great. And then just one quick numbers question for Tom. I think you threw out one when you were talking about materials and other. There was a casualty reduction. Was that anything to do with an accrual one-timer or like we saw with a couple of the other rails or is that just continued cost savings on that line?

Thomas N. Hund

No, if you remember last year we had a $15 million hit related to a one-time case that we kind of explained as being unusual. That obviously didn’t cycle and then we were modestly favorable on our normal accruals, but nothing like an unusual accrual adjustment or anything like that that’s material.

Ken Hoexter – Merrill Lynch

Great, great job on the cost side guys. Thank you for time.

Matthew K. Rose

Thanks Ken.

Operator

Thank you. And we’ll go next to Jason Seidl with Dahlman Rose.

Matthew K. Rose

Hi, Jason.

Jason Seidl - Dahlman Rose & Co

Good afternoon guys. A couple of quick questions, John on pricing I mean obviously you talked about inflation plus over the longer-term. Did you talk a little bit about what percent of the book is already under contract for 2010?

John P. Lanigan, Jr.

Well, Jason about two-thirds of our overall business is under contract, and the vast majority of that business is already locked in for 2010.

Jason Seidl – Dahlman Rose & Co

Okay, All right, good. Could you maybe John, talk a little bit about any new intermodal offerings you might be thinking about or maybe you’ve launched in the quarter because obviously one of your competitors this morning UP, talked about launching a lot of new products on the intermodal side and having a lot of success and seeing some highway conversions.

John P. Lanigan, Jr.

We’ve had the largest intermodal network for a long time and really blanket our serving territory from a standpoint of new products we have introduced some additional services in some of our lanes, but we’ve maintained this broad network for a long number of years.

Jason Seidl – Dahlman Rose & Co

Okay. Next question for Tom and I’ll let somebody else have at it Tom I heard you talk sounded like you about a one time favorable item in the quarter related to coal. I might have misheard you. Was that in this quarter?

Thomas N. Hund

Yes, it was a rate adjustment and I think I said about $20 million.

Jason Seidl – Dahlman Rose & Co

Putting on the top line?

Thomas N. Hund

It’s within coal revenues, and it is just, would be included within mix.

Jason Seidl – Dahlman Rose & Co

Be in the mix?

Thomas N. Hund

Yes.

Jason Seidl – Dahlman Rose & Co

Okay, perfect.

Thomas N. Hund

Not in price or volume.

Jason Seidl – Dahlman Rose & Co

Okay. Fantastic. That’s all I needed. Gentlemen, thank you so much for the time as always.

Matthew K. Rose

Thanks Jason.

Operator

Thank you. Our next question is from William Greene with Morgan Stanley.

William Greene – Morgan Stanley

Yeah. Hi. Good afternoon.

Matthew K. Rose

Hi Bill.

William Greene – Morgan Stanley

I’m just wondering, Matt if I can ask for a little bit of clarification maybe on your guidance comments and that is if you look at what you said in the first quarter you said if volumes were down about the same as they were in the first quarter, if they ran at that rate in the second, you do about $1 per share and obviously you did much better. So I’m kind of trying to think about if we run down about the similar level why we wouldn’t be towards the upper end and maybe similar to 2Q or even better given that I think the costs will probably continue – you will continue to get efficiency if you will?

Matthew K. Rose

Well I mean we are going to continue to get efficiency. We’ve got a couple of headwinds though that Tom talked about and again there’s a little bit of art here. We just don’t have a lot of transparency. All we’re really saying is we’re not expecting to see the same step up in volumes that normally we would see between the third and second Q in a normal year. Now that may happen later in the quarter, but we’re not expecting to see it.

William Greene – Morgan Stanley

Okay got it.

Thomas N. Hund

Maybe I can put a little more precision around some of those headwind things, which we’re seeing. Despite those we think we’ll be able to overcome those. First of all, the 4.5% wage increase going to cost about $30 million. It’s about $0.05 a share. We talked about the coal item that just got a question that’s probably about, $0.03 in the interest adjustments and unwind hedges is two. So say the unusual items in the quarter are also a nickel we have to overcome and then the final thing is fuel. Fuel as we look at all the puts and takes fuel is probably going to cost as an extra nickel in the third quarter compared to the second. So just looking sequentially we think there is about, just want to add all those up its about $0.15 stop we’re going to overcome and despite that we think we still get kind of into that neighborhood.

William Greene – Morgan Stanley

Okay, that helpful, thanks. And then John you mentioned on the contracts you’ve got the vast majority of the two-thirds locked in already what’s the increased that’s locked in on those?

John P. Lanigan, Jr.

Certainly inflations plus Bill.

William Greene – Morgan Stanley

Okay, good. And then Matt, one last question for you and that is, as we look at kind of how beyond is moved sort of over the years it seem that you’ve moved a little bit away owing equipment toward more of sort of leasing that out or having other lease it actually for you which is verbalized your cost. So when we think about the recovery does that mean you might have less leverage to a recovery on the margin than maybe some that have continued to own or how do you think about what you’ve tried to do there?

Matthew K. Rose

Yes. So, the only business unit that we’ve really changed over the last five years since our intermodal business in regard to containers and, I don’t think that’s the case I think that there are just we believe on the container side that the customers need to control the containers if you will, the trucking companies need to own them. And so we look at all of these things and outside of again intermodal containers everything else pretty much looks like where we are prior to the last five years.

William Greene – Morgan Stanley

All right. Thanks for the time.

Matthew K. Rose

Thanks

Operator

Thank you. We have a question from Edward Wolfe with Wolfe Research.

Matthew K. Rose

Hi, Ed.

Edward Wolfe – Wolfe Research

Hi, good afternoon. Can you talk a little bit about you mentioned bringing back some furloughed employees? Are you bringing back any cars or locos also and can you give us some numbers on all three of those if you’re?

Carl R. Ice

The numbers of the furloughed employees coming back are inherent in the charts that you saw there. We brought back around 5 or 600 employees and as I said that’s primarily due to vacation in this period and a little bit about the hours of service in their SIA. In turn cars…

Edward Wolfe – Wolfe Research

A little attrition.

Carl R. Ice

A little attrition yes. Cars and locomotives, we really haven’t brought any back to any large degree. We're about where we have been?

Edward Wolfe – Wolfe Research

If there was a late pickup seasonality or anything like that how long does it take to make those decisions and I guess how much volume needs to comeback before you need to start pulling cars and locomotives out?

Thomas N. Hund

Ed I will answer that for Carl, he is ready to go. Let me be very clear. You do not have to worry about our ability to response. We’ve done this. We know what we’re doing. We will not miss any freight because of planning or lack of resources.

Edward Wolfe – Wolfe Research

Okay. Tom, switching gears for a second if I look at material and others at a $145 million I can’t find the expense anywhere near that low for at least 12 or 13 years. What’s driving that down and is there anything one-time is in there?

Thomas N. Hund

No, the big thing looking on a GAAP basis I mean that’s where the environmental issue was last year, but other than that, no, I mean it’s across the board, it’s just a lot of different things, lower casualty cost, good lower environmental. As we talked about PI just a little bit lower. There is really nothing beyond that. It’s just a lot of smaller things.

Edward Wolfe – Wolfe Research

Is that a good number to bring forward, give or take to third quarter about 145, 150 something like that?

Thomas N. Hund

Well, we did talk about our capitalized overheads go through that number. And so that’s where the capital program winding down earlier and also been smaller that’s going to definitely affect that number as we go into the quarter. So, although that also affects comp and benefits too. So I guess we have to look at this split between those two I don’t have that, at my fingertips right now.

Edward Wolfe – Wolfe Research

Okay.

Thomas N. Hund

Probably both be a little bit higher as we go forward.

Edward Wolfe – Wolfe Research

Okay. Can we talk a little bit more on the pricing side, John you talked about 3% including RCAF 4% without it. How do those same numbers look in first quarter and in fourth quarter? In other words that the 3% including RCAF is that down from 5%, is that was that down from a quarter into quarters again.

Thomas N. Hund

Yeah its in the same neighborhood.

Edward Wolfe – Wolfe Research

The same neighborhood of three and fourth give or take?

John P. Lanigan, Jr.

Yeah give or take. You know that RCAF numbers bounce around a little bit. So it has an impact but it is in the same neighborhood.

Edward Wolfe – Wolfe Research

Okay. Thanks for the time guys.

John P. Lanigan, Jr

Thanks Ed.

Operator

Thank you. And next we have Randy Cousins with BMO Capital Markets.

Matthew K. Rose

Hi Randy.

Randy Cousins – BMO Capital Markets

Afternoon. And Tom I just want to make sure I understood what we might classify as kind of like one time items in this quarter. Did you say there was a $10 million favorable adjustment on the interest rate line for the second quarter?

Thomas N. Hund

For the third quarter I am sorry for the second quarter yes, yes for the second quarter.

Randy Cousins – BMO Capital Markets

So we’re looking at a run rate again for interest if Q3 if we should take the Q2 number and add $10 million bucks.

Thomas N. Hund

That’s exactly right. And what that $10 million was, remember last quarter we had a loss on mark-to-market of some interest rate hedges where we are opted not to do the borrowing, but when we unwound those hedges this quarter the markets had moved in our favor and so we ended up with a gain on those and that’s what the 10 was….

Randy Cousins – BMO Capital Markets

Okay. And then you said again $20 million was in this quarter for a coal case where you got a favorable adjustment. So, should I take the existing number in sort of backout 30 or the reported number of backout $30 million for sort of at the pretax line what we might call sort of onetime each type items. Is that correctly to approach it?

Thomas N. Hund

Yes.

Randy Cousins – BMO Capital Markets

Okay. Could you talk a little about the fuel hedge program? You talked about the issue on a year-over-year with the surcharge lags et cetera, et cetera. What’s the expectation for the third quarter in terms of sort of loss or gain on the hedge program and what’s the thinking heading to 2010? Are you going to wind this thing down and just go naked or how you’re going to approach it? Are you increasing the hedge right now? What’s the strategy?

Thomas N. Hund

No. I guess first of all I will tell you, look at our 10-Q which will be filed probably tomorrow and what you’ll see is we still are staying modestly in the standardized hedging program. But I’d look at the Q and read the details in there. As far as next quarter, let’s see, I believe, I think what I’ve said in earlier comment when you add up all the pieces, we expect that fuel including hedge, including fuel cost itself, including the impact of fuel surcharge its probably going to cost us about a nickel. I’m talking sequentially quarter-to-quarter from second-to-third.

Randy Cousins – BMO Capital Markets

So, it’s $0.05 quarter-to-quarter, it’s not $0.05 year-over-year.

Thomas N. Hund

No, that’s correct.

Randy Cousins – BMO Capital Markets

Okay.

John P. Lanigan, Jr

And I would say same thing in that matter.

Randy Cousins – BMO Capital Markets

Okay, Shifting gears, a question for John. Just looking at the arc for your intermodal business, the domestic was down 17%, 18% and the international was down 12. Some of that’s obviously fuel. Can you give us some sense is to how much of that sort of relative shift is due to pricing in the domestic seen as opposed to a fuel issue.

John P. Lanigan, Jr.

Fuel is the bigger component of it for sure.

Randy Cousins – BMO Capital Markets

So and then in terms of sort of on a go forward again look at domestic cart do we see the sort of situation where the, right now domestic arc is almost on top of international, typically what we intend to think a sort of domestic it gets a better rate and international. How should we think about this on a go forward basis?

John P. Lanigan, Jr.

Part of challenge is mix even within domestic because the higher rated business like the LTL and the small parcel is down pretty significantly as you know by following those sectors as well. So part of its going to depend upon what the mix is within domestic going forward.

Randy Cousins – BMO Capital Markets

Okay and one last question just on the intermodal again. Can you give us some sense us to what happening with the transcon business, are you seeing more pressure on the international transcon are you seeing pressure across the entire international portfolio.

John P. Lanigan, Jr.

Well the international business obviously is down dramatically because of global trade and what’s going on with the U.S. consumer and not consuming right now and when you look at all the port statistics and where they are going west coast ports were actually worse in June on a comparable basis and they were in May. So really until the consumer starts to come back to the table and increase demand there is going to be pressure in that international segment.

Randy Cousins – BMO Capital Markets

But you are not seeing any difference between the step that you are saying moving from LA the Chicago versus LA to interchange with one of the Eastern roads.

John P. Lanigan, Jr.

No

Randy Cousins – BMO Capital Markets

Okay, good, thank you. That’s it.

John P. Lanigan, Jr.

Thank you.

Operator

Thank you. We have a question from Gary Chase with Barclays Capital

Matthew K. Rose

Hi Gary.

Gary Chase – Barclays Capital

Hello everybody, couldn’t decide that was a morning or night in the long day. Wanted to ask a couple of quick ones of Tom if you could. The first is I know when you’re going over the hedging disclosures in the, in the slides. You pointed to that I think it was $68 million. But I think that’s a year-on-year number and if I’m not mistaken I think last quarter you were expecting a $70 million loss within this period alone. Did we misread that as part of the hedge book shifted around? Have you move that into later parts of the year or is it really a $68 million in period loss?

Thomas N. Hund

I’m little confused as to the 68. The 68 that’s the net I think that’s the…

Gary Chase – Barclays Capital

Right. I’m looking on page 35, the slide you have that’s as a reconciling year-to-year.

Thomas N. Hund

Yeah, all that’s year-over-year and that number would be let me catch up here and I show you to the right page, but that should be last years gain and this years loss combined. So I believe what we said yeah I said $45 million loss this year versus the benefit of 23 last year.

Gary Chase – Barclays Capital

Right. And I guess we had expected just based on the 10-Q that it would be closer to 70 and something just says that you had said that and just wondering if any other hedges sort of shifted into later periods at the year if you moved the book around or if?

Thomas N. Hund

No, no what happens is fuel price moves.

Gary Chase – Barclays Capital

Yes.

Thomas N. Hund

Because it’s based upon the average across the quarter and fuel prices have clearly risen in the quarter. So I’m guessing I don’t think we quoted a number, but that number might have been the mark-to-market out of the Q or something like that. But we don’t shift them between quarters, but fuel price moves and that changes the value of the hedge.

Gary Chase – Barclays Capital

Okay. So no change to where you are there. What would turn the incentive compensation back on and that would be a problem to have, but what would turn that back on in moving back in the other direction.

Thomas N. Hund

I think it’s really volume at this point in time and generating more earnings. I mean everything, all the rest of our incentive comp areas around safety and velocity are all doing fine, it’s really the earnings piece.

Gary Chase – Barclays Capital

Okay, so it’s about performance expectations and just one last quick one. Any ongoing impact from the $20 million is that material or just in this period.

Thomas N. Hund

Very, very modest going forward just baked into normal results.

Gary Chase – Barclays Capital

Okay, I appreciate you guys.

Thomas N. Hund

Thank you.

Operator

Thank you. Our next question is from Christ Ceraso with Credit Suisse.

John P. Lanigan, Jr.

Hi, Chris.

Christopher Ceraso – Credit Suisse

Hey, thanks. How are you? Just a couple of things left here, the domestic intermodal business down 15% if I remember from some of the other railroads it seem like the domestic intermodal business was stronger and everybody is having trouble with international. Are you losing market share are other guys getting into business that they weren’t doing before? Can you explain why it looks like maybe your domestic intermodal is a bit softer?

John P. Lanigan, Jr.

Well, there is a big different in the east and west. The east has just really discovered the intermodal market on a short haul basis over the last couple of years and so their comps are coming from a much, much lower base as they start to build some intermodal density within the east, east to east origins, so that’s the biggest difference in talking to east versus west.

Christopher Ceraso – Credit Suisse

We heard similar stuff from the Canadian rails too. Is that the same phenomenon there?

John P. Lanigan, Jr.

That’s whole different market.

Christopher Ceraso – Credit Suisse

Okay. The other question I had I think you’ve given us the punch line, but what is the RCAF that you expect in Q3.

Matthew K. Rose

I think its, what is the fuel you assume.

Christopher Ceraso – Credit Suisse

Well, if fuel stays steady here

Matthew K. Rose

It’s in a different range. It’s in the very high teens around 20 somewhere in that range.

Christopher Ceraso – Credit Suisse

Thanks guys.

John P. Lanigan, Jr.

Yes, negative just like this quarter.

Christopher Ceraso – Credit Suisse

Right, yes.

John P. Lanigan, Jr.

Yes.

Christopher Ceraso – Credit Suisse

Right, okay. Thanks

Operator

Thank you. We’ll go next to Walter Spracklin with RBC Capital Markets.

Matthew K. Rose

Hi. Walter.

Walter Spracklin – RBC Capital Markets

Hi guys. Just had a question back on the volumes going into Q3, you had mentioned if we don’t get that seasonal uptick just for our own purposes if we were to measure or determine if that seasonal uptick is not coming wouldn't it mean that we would have a deterioration in the year-over-year weekly car load volumes that we see. If last year you got the uptick we’ve been clipping along at 20% down. If we were to get 20% down for the rest of the year then that would imply we are getting the uptick, but wouldn’t it have to be mathematically when we have the see a bigger drop in volumes in order for us not to see that seasonal uptick?

Thomas N. Hund

I think what we were saying was off of John’s chart. If volumes stay sequentially where they’ve been for the last quarter or more, which is kind of sitting in that 155 to 160,000 loads that’s what we are talking about, so think of it sequentially versus year-over-year.

Walter Spracklin – RBC Capital Markets

I guess if sequentially it stays the same shouldn’t we see the decline be more pronounced than what we had the first half of the year.

Matthew K. Rose

I don’t think so, yeah I think we started to seeing the business slowdown in the third quarter last year. So you have to take that into account too.

Walter Spracklin – RBC Capital Markets

So we didn’t see the uptick this time last year either.

Matthew K. Rose

No, we saw it wasn’t as near as pronounced as it has been in the past. I mean we all remember us talking about where is the peak? Right.

Walter Spracklin – RBC Capital Markets

Okay. Moving on, just on - in terms of if we had to take a step back and look at railroad competition in general there was obviously some movement in one of your customers and we’re seeing the same thing in Canada, we’re seeing CM start to pick up business that traditionally had been CP’s for a very long time. Can you give us any color on with everything that’s going on in the current economy, are you seeing interrailroad competition picking up at all or is it consistent with prior levels and these are display?

John P. Lanigan, Jr.

I think it’s consistent with prior levels. We’ve competed in good times. We compete in times like this and that really hasn’t change.

Walter Spracklin – RBC Capital Markets

Okay, all right. That’s all my questions. Thanks.

Matthew K. Rose

Thank you.

Operator

Thank you. Then we’ll go next to Matt Troy with Citigroup.

Matthew Troy – Citigroup

Yeah. I know you talked about deployment of capital earlier and taking a very conservative wait and see approach. Just curious assuming things do get better one day the sun does rise. How do you prioritize your deployment of capital? I assume it would be balanced between shares repurchase and CapEx. But what are the hurdle rates or what are you looking for before you start to open that wallet and how do you prioritize, where you put it to work?

Matthew K. Rose

Well, the good news is on putting it into capital. We’ve got a lot of capacity to be able to rest on for a long time.

Matthew Troy – Citigroup

Right.

Matthew K. Rose

It will really come down to a more tactical decision of share repurchase versus dividend and a little bit will depends on what happens with cap gains taxes, things like that. But right now I don’t see us needing a lot of expansion capital outside of our new technology capital for positive train control, but outside of that, the commitments that we’ve already got for our locomotives, we are going to be here for a while.

Matthew Troy – Citigroup

All right. And I appreciate it that it's more art than science, but are there hard targets you need to see either volumes on the system or economic read that lets you open that wallet or is that more feel as we progress into whatever we’re in right now?

Matthew K. Rose

I think we’ll all see it. I mean we saw it coming down. This business is so granular because you get to see weekly loadings and we’ll all know when this thing starts to recharge.

Matthew Troy – Citigroup

Okay. One follow-up in relation to the Hub Group obviously it’s a competitive business, but just wondering longer-term as you look at your intermodal network. The loss of that business obviously allied to just take a strategic look from a very high level. Do you see a change in terms of your direct investment and direct selling the role the intermediaries might play longer-term? How do you think of the intermodal business and your cost to serve and your cost to go to market and the investment you might make? Is that seems to be the crucible where in most of the share gain can happen off the road? Is it a worth a greater investment there to go direct overtime?

John P. Lanigan, Jr.

Well the direct model is a difficult one to just flip a switch on, because it’s been established over a long period of time that the trucking companies, steamship lines, intermodal marketing companies et cetera have had the direct relationship with the shipper. And that railroads have provided the underlying line haul capacity on rail and when you look at the types of relationships that a lot of those entities have with the shippers, particularly on the domestic side, you’ve got a J.B. Hunt and a Schneider and people like that that provide a wide range of services to their customers not just intermodal but over the road trucking, dedicated trucking those sorts of things. We look at that on a regular basis and to this point we’ve maintained the model that we have.

Matthew Troy – Citigroup

Okay and yes not asking for any drastic moves, but just wondering if you are looking at it. Okay that’s all I’ve got. Thank you very much for the time.

Matthew K. Rose

Thank you.

Operator

Thank you. Then our final question is a followup from William Greene with Morgan Stanley.

Matthew K. Rose

Hi Bill.

William Greene – Morgan Stanley

Hey there. Just two quick questions. One, automotive, you are not a big player there, but you’ve said in the past you wanted to be potentially, or at least you’ll bid on some contracts as they come up. Do you have the equipment to handle any contract wins there, or would you need to go out and make some pretty big capital investments?

Matthew K. Rose

We have plenty of equipment.

William Greene – Morgan Stanley

Okay. And then I just wanted to followup on the comment you made about CapEx. I guess it would be safe to say that we could run lower for longer on CapEx here given the kind of capacity that’s here, so maybe there is actually a cash flow. I don't know, bonus, so to speak, coming in the next few years as volumes recover.

Matthew K. Rose

Yeah I mean I think you've got to really look at the individual components of the CapEx. Expansion capital will be down greatly. Locomotive capital for us we’ve got a multiyear commitment. So we got a couple of years of locomotive capital that we’re still going to be hanging in there with. The new kid on the block, as I’ve said will be train control capital that will be something that we haven’t seen in the past. And then over a longer period of time, our maintenance capital will vary with gross tons and, it depends on the volume whether or not and how much we take out of that if you will.

William Greene – Morgan Stanley

Sorry. Just for a clarification, though, are you saying then that this will kind of run inline with revenue is more the way to think about it or that it can run at a lower level?

Matthew K. Rose

No I mean on the maintenance capital, again, you’ve got to break each of these three or four components apart. On maintenance capital long-term it will run it will be linear with gross ton-miles.

William Greene – Morgan Stanley

Okay thanks.

Matthew K. Rose

All right Kathy. We have done it.

Operator

That’s all there are in queue, yes.

Matthew K. Rose

All right. Everybody, we’ll talk to you next quarter and thanks for your interest and your participation. Have a safe day.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.

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[User 388717:]

Cap & Trade...the beginning of the end.

Jul 24 09:05 AM