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Executives

Matt Rose - Chairman, President and CEO

John Lanigan - EVP, CMO

Carl Ice - EVP, COO

Tom Hund - EVP, CFO

Analysts

Ken Hoexter - Bank of America

Tom Wadewitz - JPMorgan

Jon Langenfeld - Robert W. Baird

Bill Greene - Morgan Stanley

Ed Wolfe - Wolfe Research

Randy Cousins - BMO Capital Markets

Matt Troy - Citigroup

Gary Chase - Barclays Capital

Jason Seidl - Dahlman Rose

Chris Ceraso - Credit Suisse

Walter Spracklin - RBC Capital Markets

Justin Yagerman - Deutsche Bank

Donald Broughton - Avondale Partners

Burlington Northern Santa Fe Corp (BNI) Q3 2009 Earnings Call Transcript October 22, 2009 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the BNSF corporation conference call hosted by Matt Rose. (Operator Instructions). I would like to turn the conference over to BNSF Chairman, President and Chief Executive Officer, Mr. Matt Rose. Please go ahead, sir.

Matt Rose

Good afternoon, everybody. Welcome to our third quarter financial presentation. With me here in Fort Worth are John Lanigan, EVP, Chief Marketing Officer, Carl Ice, EVP Chief Operations Officer and Tom Hund, EVP and Chief Financial Officer. Our presentation today is available by webcast so I will start by directing everyone's attention to our first slide regarding forward-looking statement.

This statement basically cautions everyone that any forward-looking information provided here today could be affected by a number of factors which could cause actual results to differ materially from any forecast information we provide. I would also like to mention that we will be providing non-GAAP measures today in our commentary and ask that you refer to the Investor Relations page on our website with the reconciliation to GAAP.

In the third quarter, we reported earnings per share of $1.42 which includes a $0.06 benefit from an adjustment in Western Field’s rate case that Tom will provide more detail on in his section. This compared to earnings per share of a $1.99 for the same quarter last year. Freight revenues were 3.49 billion compared to 4.77 billion last year on lower volumes and fuel surcharges partially offset by improved yields.

John will give you more detail about the change in revenues as well as a report on the results for each of our business units. Operating expenses were down 27% driven by continued strong cost controls and productivity improvements. Decreased unit volumes and a decrease in the fuel reflective of the significant decline in oil prices. Our resulting operating ratio was 74.2%. Carl will give you more information on our cost controls and productivity measures. Now I'll turn it over to John.

John Lanigan

Thanks, Matt. In the third quarter we had a 27% decrease in freight revenue of which about 12% was due to lower fuel surcharge revenue. Our units handled were down 17% with RTMs down 11%. We experienced a $1.3 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 2% measured on a same-store basis which includes contracts that utilize the RCAF escalator which was at a negative 18% this quarter.

As we have discussed our methodology to calculate price includes the fuel component of the RCAF escalator. Excluding that component price is 3%. With our mix of business and current volume trends along with excess trucking capacity, we expect our pricing to remain similar for the remainder of the year. The weakness in our consumer product’s higher rated segments was a key driver of the change in mix.

We expect this trend to continue through the end of the year. Finally, third quarter fuel surcharge revenue of $312 million was $725 million less than last year largely due to a 40% year-over-year decline in highway diesel fuel price.

Turning to the individual business units. Coal revenues were down $107 million or 10%. This was offset in part by the $30 million benefit related to western fuels which Tom will discuss later. Volumes are down driven by lower demand for electricity generation, mild weather, effects of the recession and historically high inventories. In our agricultural products business units revenues were down 21% on a 9% decline in volumes. Whole grains volumes were down by 12% in the third quarter driven by two key factors.

First, large global crop production is leading to increased competition for the US mostly in weak markets. Second, the global economic slowdown tempered demand for grain and grain products particularly those used for higher protein animal consumption. Grain exports in the Texas gulf were down 37% on lower global demand for wheat. On the domestic side grain volume was down 11% while Mexico volume was down 23%. Grains product volume was down 5%.

Most 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% on a 27% decline in units. All five segments of industrial products continue to experience negative revenue growth reflecting the broad based recession. Construction products had the largest revenue drop driven mainly by steel and taconite as well as minerals and clays.

While steel and taconite demand was still declining in the third quarter, we did see several plants reopening. Low oil and natural gas prices led to decreased demand for drilling materials which led to the decrease in minerals and clays. Building products revenue declined by 37% primarily due to lumber and panel, both highly correlated to housing starts. Lumber and panel volumes were down 29% versus the third quarter of 2008 which was an improvement over the Q2 year-over-year decline.

Paper volumes dropped 28%, while chemicals and plastics’ volumes decreased by 11%. Consumer products saw a 36% decline in revenue on a 22% decline in volume. These results continue to reflect the impact of the US recession highlighted by weak consumer spending. Domestic intermodal reported a 33% decline in revenue on a 17% decrease in units driven by weak domestic over-the-road trucking trends and reduced volume from Hub Group that we discussed last quarter.

The global recession on trade continues to impact international intermodal delivering 39% lower revenue on a 27% decline in volume. And our auto segment saw a 33% decline in revenue on a 22% decline in volume driven by year-over-year declines in new auto sales. This is an improvement from the 44% year-over-year volume decline we saw in the second quarter. Here are BNSF’s weekly units to the week ending October 17, 2009.

As you can see the declining volume trend in the first quarter has stabilized through the second quarter with a modest increase in the third quarter. The fourth quarter is trending similar to third quarter with the normal seasonal downturn anticipated around the holidays.

Coal transportation is continuing to moderate due to high-stock piles and lower electric generation. After four consecutive quarters of lower year-over-year comps, agricultural products should see some demand growth in the fourth quarter. Robust grain harvest yields have lowered US grain prices increasing export demand, mainly soybeans and corn and a weaker US dollar multiplies the price factor for Asian buyers.

Additionally weather conditions have delayed harvest. We expect industrial products’ fourth quarter volumes to be similar to the third quarter despite normal fourth quarter seasonal declines. We will continue to feel the impact of the economic slowdown especially in construction and building products. Consumer products remains challenged by weak demand for consumer goods. Now I'll turn it over to Carl for a review of operations.

Carl Ice

Thanks, John. Good afternoon, everyone. As always over the next few minutes we will talk about velocity, service and productivity. Locomotive velocity continues to remain strong. The third quarter results were up almost 6% compared to last year. And we showed improvement over the second quarter which as you recall was our best performance since 2003. Car velocity also showed strong performance, we closed the quarter at a system level of 229 miles per car, a 12% increase compared to 2008 and a third quarter record.

This improvement was driven across all of our business units. One of the benefits of improved car velocity and network fluidity is an improvement on our on-time performance. During the third quarter we achieved a 6% improvement over the last year with each of our business segments continuing to show substantial improvement over 2008. As always we will maintain our focus on delivering consistent reliable service to our customers and matching our resources to demand. We have had a number of questions lately about how sustainable our cost reductions are as volume recovers. So we thought it would be helpful to review our point of view about variability and our performance against those variabilities.

As we have communicated to you in the past, we have intentionally built variability into our cost structure which has allowed us to adjust our expenses as volumes changed, but we have also been effective at adjusting the long-term and fixed expenses as well. This chart shows our changing cost for our four large functional area, business areas, business unit operations, our equipment operations and intermodal ramps, transportation or train crews, locomotive movements and so forth, the mechanical and engineering are maintenance areas.

You can see that in the business unit ops and transportation we were down very near volume in the case of business unit operations, actually over volume and we also showed good cost control in mechanical and engineering. If you compare those to the variabilities, we showed in the previous slide on 18 you can see that we outperformed how much you would expect expenses to go down by variability and that does demonstrate we have got sustainable cost controls in place.

We achieve these cost controls in our other initiatives and in productivity and service through a set of initiatives that we put through a set of interlocking reviews that have outcomes linked to financial results and to service results. One of our significant initiatives this year, we call best way. Best way is about reducing waste variability and then flexibility in our operations and about creating more standardization across the network. As we have discussed with you in the past it began in transportation where we saw a very strong improvement.

Consequently it’s become our vehicle for process improvement in the other areas as well. And you can see the main focus in each of the large functional areas which really come about driving consistency, reliability and standardization. As I mentioned, we have initiatives in addition to best way. One of those deals with train size and you can see that over the last three years we have continued to improve train size a little over one unit year-over-year this year which is almost 1%.

At the same time we did that, however, our efforts in our terminals including best way have led us drive well down which is typically counter to thinking about big train size in a down-volume environment. So we feel very good about that performance. As we turn to some of our more traditional volume measures you can see that our active inventory decreased slightly more than our declines in unit volume.

In people productivity, our workforce was down about 9% versus the same time last year consistent with the trend we have seen in previous quarters. In fuel efficiency, we achieved an all-time gross ton miles per gallon of 860. This was a 5% improvement and it’s driven by combination of some favorable mix, but also our investment in newer locomotives, in new technologies as well as operating practices that drive improvement in terms of fuel efficiency.

We continue to anticipate improvement in these areas. Last quarter we showed you the slide -- showed you a set of slides about our active locomotive equipment and equipment fleet as well as our TY&E workforce. We repeat them this quarter. You can see we move locomotives from the fleet as demand fell and then as John showed you, our stabilizing demand the number of locomotives we have had was stabilized as well. At the moment we have about 900 locomotive stored and we did return 200 off of lease earlier in the year. We have about 28,000 freight cars stored. And employee base has also been adjusted with volume changes.

We had a [peak] of furloughs in our train service employees of a little over 3000. At this point I’m worried about 2800. We did have some spike that you see there in our reduction during June and July driven primarily by vacation. And we will continue to adjust our workforce as volume dictates. So going forward we will continue to balance our resources with that of volume demands and will maximize our velocity and productivity levels.

Tom Hund

Thanks, Carl. As Matt already mentioned earnings per share in the third quarter was $1.42 and $1.36 after reflecting an adjustment of $0.06 per share and this is a favorable adjustment to the charge taken in the first quarter of 2009 related to the Western Field coal rate decision. This reduces the final amount to be equal about $120 million and payment of that amount we made this quarter.

After adjusting for this items earnings per share in the third quarter was down 32% reflecting the impact of lower volumes, fuel headwind and wage increase for our scheduled employees and I'll provide more detail on fuel and wage increase a little later. Earnings per share was $0.20 higher than the guidance we provided on last earnings call based on volumes remaining flat between the second and third quarter and as John pointed out when he showed you the weekly carload volume his increased in the third quarter and many of you adjusted your earning estimates for those higher volumes.

So about $0.15 of the increase was driven by 2% higher volumes and then additionally lower interest expense and income taxes which I will explain in a moment added about $.50 cents per share. Third quarter operating income for 2009 was 901 million. After adjusting for the coal rate case decision operating income was 871 million down 28% from 2008. Our operating ratio was 74.2% for the third quarter and about flat with 2008 on an adjusted basis. Operating expense was $2.694 billion for the quarter, $1.005 billion or 27% lower than the third quarter of 2008.

This decline was driven by lower fuel prices, continued productivity improvements and variable costs associated with the lower unit volumes. Exclusive of the effect of fuel prices operating expenses were down 12%. As you see on the charts to follow except for depreciation and carving out the lower effective fuel prices, every expense category was down year-over-year with decreases ranging from 14% to 18%.

Compensation and benefits expense was $872 million, down $141 million or 14% from 2008 and compensation of benefits expense for employee decreased 5% and a 9% decline in headcount. These results were achieved despite the 4.5% wage increase for our scheduled employees who make up the vast majority of our workforce. I want to give you some additional information on compensation and benefits. Wages and benefits were down $91 million from 2008, the lower headcount more than offset the wage increase which cost us about $30 million in the quarter.

Also incentive compensation for our exempt and scheduled employees was down $44 million on year-over-year due primarily to lower earnings. Now looking to the fourth quarter, the scheduled wage increase will again cost us about $30 million. At current volumes headcount savings will be similar to the third quarter. Additionally in the fourth quarter we will have lower expense credits for capital labor due to both the smaller program and an earlier completion.

And finally the third quarter is the last quarter for the significantly favorable year-over-year comparisons on incentive compensation. Purchase service expense was $453 million for the third quarter, down $84 million or 16% from 2008. The decrease was due to variable expenses on lower volumes which led to reduced costs in ramping, drainage, haulage and locomotive maintenance as well as lower spending for professional and other services.

Depreciation expense was 386 million, up 37 million or about 11% from last year as a result of our continued capital investment. Equipment rent expense was $194 million for the third quarter, down 15% or 35 million from 2008 due to improved velocity, lower volumes and the return of leased equipment.

Material and other expense of $183 million, was down 18% or $39 million from the third quarter of 2008. This decrease was the result of reduced volumes and strong cost controls along with lower casualty and personal injury costs. Finally fuel expense of $606 million was 55% or $743 million lower than the third quarter of 2008. The average fuel price per gallon including hedge was $1.99 and this compares to last year's third quarter price of $3.72. This chart provides a little more detail on fuel expense. Fuel expenses were down $546 million as a result of lower prices.

The fuel usage was also significantly lower which reduced fuel costs by $243 million. Gallons burned were down by about 17% year-over-year. As Carl already mentioned, we had an all-time record in fuel efficiency. These reductions were partially offset by hedging losses of $35 million this year versus a benefit of $11 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 we’d mentioned in previous quarters, rising prices in the first half of 2008 had a negative impact on our earnings. And this trend flipped to a positive impact in the second half of the year as fuel prices fell.

When we add up the pieces of the impact the fuel prices on expense, hedge and surcharge on a year-over-year basis the third quarter earnings include about an $0.08 per share headwind. The fuel surcharge lag effect was a major component of the headwind and at current forecasted fuel prices, the net year-over-year impact of lower fuel prices hedging and fuel surcharge is expected to result in a headwind of about $0.20 per share in the fourth quarter and this includes the fourth quarter 2008 fuel surcharge lag effect shown above of about $200 million.

Interest expense for the third quarter was $127 million, up from 2008 on a higher average debt balance partially offset by decreases to interest expense of about $15 million or $0.03 per share related to favorable tax and other settlements. Adjusting for these items and including our recent borrowing, we expect interest expense to be about $150 million in the fourth quarter. Also the same tax supplements provided a $0.02 per share benefit reducing the third quarter effective tax rate to 36.9%.

In the fourth quarter, we expect the rate to return to more normal 38%. Our capital program for 2009 remains at $2.600 billion, down $250 million from last year. In addition to lower expansion spending, a benefit of lower volumes has been our ability to install rail ties and ballast at a lower unit cost.

The balance sheet cash was $1.161 billion at the end of the third quarter of which about $500 million is held in our captive insurance company. We borrowed $750 million in the third quarter at a favorable rate of 4.7%. Comparing third quarter to fourth quarter and excluding any effects of volume changes, normal seasonality and non-recurring items are expected to reduce fourth quarter earnings.

Lower overhead credits from our capital programs which impact the compensation of benefits purchase services and [material] and other lines will reduce earnings per share by about $0.10. Winter always impacts fuel efficiency, velocity and other aspects of our operations, but we really can't quantify that and another $0.04 is attributable to higher interest expense. And finally the effective tax rate will return to a more normal level. Now Matt will provide some final comments.

Matt Rose

All right, thanks, Tom. As John, Carl and Tom have shown you, our third quarter results were strong during another quarter of soft volumes. Service truly has been outstanding as reflected in the on-time performance and the other efficiency measures Carl showed you. While volumes have been down, we have taken the opportunity to further capitalize on our tradition of ongoing productivity improvements, which will provide significant operating leverage as volumes increase.

In addition to improving service, those productivity initiatives should offset most if not all of our annual cost inflation. Considering the fourth quarter items, Tom explained coupled with a typical seasonal downturn around the holidays, we expect fourth quarter earnings per share to be in the $1.10 to $1.20 range.

Think of it this way. Third quarter was $1.42 per share, but when you normalize for [Western Fields], interest and taxes take $0.10 off for capital overheads and factor in winter and the seasonal downturn, you'll be in that range. Looking long-term, we continue to like the BNSF story in part due to several secular factors such as rising fuel prices, carbon growing in importance and a highway system that is congested and is in need of repair. The combination of factors like these along with significant operating leverage positions us for a strong future. With that, Kathy, I think we are ready to take some questions.

Question-and-Answer Session

Operator

Thank you, Mr. Rose. (Operator Instructions). Our first question is from Ken Hoexter with Bank of America.

Ken Hoexter - Bank of America

Can we get a clarification on the slides it said peer pricing was 2%, but I think John in his overview said 3%. I just want to understand that.

John Lanigan

That's the adjustment for the RCAF component, for the fuel component of RCAF. In our peer price we leave the entire RCAF calculation and price and then to make it more of an apples-to-apples, we take that fuel component out and it’s 3% without that fuel component of RCAF.

Ken Hoexter - Bank of America

I want to understand the guidance on the $1.10 and $1.20. So there are a couple of these one-time items and I want to understand what you’ve baked into that forecast because it seems a bit lower than where the consensus is looking. What are you looking for in terms of volumes, pricing and then can you just go over some of those charges maybe just in a little more detail?

Tom Hund

The GAAP number this quarter was $1.42. This makes more sense thinking about this sequentially because the year-over-year comparisons are so off between the lag and fuel surcharge and also the significant volume declines. Start with $1.42, then knock off the $0.06 related to the Western Field adjustments, you’re at $1.36. Then as we look to the fourth quarter interest will be back to that $150 million range so that's about $0.04. $0.03 of it are the tax settlements I talked about. $0.01 is attributable to the new borrowing, $750million we borrowed.

$0.04 of interest and then $0.02 is taxes. Again, the adjustment in the third quarter related to the settlements. So that gets you $0.06 down, so therefore you are at $1.30. Then from there we have got our capital program. One is smaller and two is substantially complete compared to a year ago. So it’s done earlier and smaller to start with. Like any company does in accordance with GAAP, we capitalize overheads based upon -- in our case we typically use labor dollars and capitalize overheads that encompass everything from support-type costs to supervision, to use it for small tools and other types of things in the engineering department.

And we capture those and apply them to an overhead. Given that the program is basically done we will see very few credits coming through in the fourth quarter. There was a comparable number last year, but not the $0.10 here. It was probably more like about $0.07 or $0.08. If you go through that mathematically, you’d say if my revenue was exactly the same and I adjusted for those items, I should be down to around $1.20.

Ken Hoexter - Bank of America

Just my follow-up would be on the percent of business that you've booked for next year. Can you walk us through kind of how things are shaking out as you prep for 2010 at this point?

John Lanigan

Ken, about 60% of our business is under contract, typically the rest is under some sort of a tariff. Of that 60%, about 80% of that business is locked in for next year.

Operator

We will go next to Tom Wadewitz with JPMorgan.

Tom Wadewitz - JPMorgan

I wanted to ask you about the pricing. I guess you get some noise in your numbers related to intermodal and you don't like to talk about customers, but you've got the J.B. Hunt contract which would have affected your base price number because of the intermodal pricing going down. Can you give us any sense of what the base price would have been x the impact from that, would that have added another point to the base rate?

John Lanigan

Tom, that will get us into talking about specific customers, so we are not going to go there.

Tom Wadewitz - JPMorgan

I mean, is it fair to say that that would be a material impact, though, in terms of just the way the mechanics of that contract work that they would flow through and affect your base price?

Matt Rose

Tom, I just think that you have to take it up a step and that is the domestic truck environment is very, very competitive. You see that in the numbers that you study and look at. And so our domestic intermodal business is being affected by that. Our big customer J.B. Hunt is one element of that but, it's certainly not the driver. The whole truckload domestic side is in a pretty tough condition right now with the overcapacity of not taking trucks out of the network like they usually do in a slowdown like this.

John Lanigan

And it's not just the truckload, it is also LTL and Parcel as well, Tom.

Tom Wadewitz - JPMorgan

I didn't mean to get too granular but I guess there is probably some impact. Can you take it up maybe a step further, Matt and just give us a sense of how you're looking at pricing? Your competitors' results earlier in the day, maybe drove a little concern on what was happening with pricing. From their perspective and my guess is that you're saying that the 3% base price is lower than what we've seen. I think 4% the last quarter, could be a point of some concern. So I wonder if you could just run through your approach to pricing, whether anything has changed and maybe just how you are looking at pricing today.

Matt Rose

I think if you look again at what's going on in terms of falling volumes across the whole supply chain, that our pricing is quite frankly, quite admirable of what we are still being able to get in a market like this. We very much know that we've got to be able to pay for the infrastructure and so we have got to be able to offset inflation. So price is going to be a part of what we do. Compared to other competitors we are just not going to go over there. But compared to the market in general, compared to what we are seeing on the domestic truckload and the LTL and Parcel line, I feel pretty good about where we are. What we need to see, of course, over the next several quarters is gross ton miles to start to come back to the network and all will be just fine.

Tom Wadewitz - JPMorgan

Your approach to price has not changed recently in terms of the impact going down to 3% base rate in the third quarter?

Matt Rose

Tom, we don't have a target of 3% or 4%. It depends on the market, depends on the customer.

Operator

We have a question from Jon Langenfeld with Robert W. Baird.

Jon Langenfeld - Robert W. Baird

On the coal side you had made some comments that almost leading us to believe that things are getting worse there. Could you just clarify your comment there? Because just looking at your numbers I mean certainly on a sequential basis, the volumes haven't been good year-over-year but they don't seem to be getting worse. So could you just give us an outlook there as you go through the next couple of quarters?

John Lanigan

Well, from a coal perspective what's going to impact the next couple of quarters, the most will be the economy and how the economy comes back and starts to generate more electrical demand and couple that with weather that influences electrical demand as well. So it is almost impossible to forward, project exactly what's going to happen in coal because of those two factors, but those are really going to drive a lot of the results from a coal perspective.

Matt Rose

The reality of the stockpiles that everybody is aware of and it’s written about, it's going to be with us for a while and the best thing we can have is for the economy to start coming back. That will help our coal business as much as anything. Weather patterns will impact it and the stockpiles will start to go down. But we have got an overhang out there that's pretty significant. As far as low gas prices, we don't think that PRB coal is being negatively impacted by the gas prices at all.

Jon Langenfeld - Robert W. Baird

But your comments on slide 12 that says coal demand continues to moderate on the outlook that's not to suggest that it gets worse, just no signs of an increase. Is that the right way to read that?

Matt Rose

Yes, that would be closer to the trend.

Jon Langenfeld - Robert W. Baird

Then on the Ag side, with the prospects for a record harvest or near record harvest, have you started to see the grain demand move out of some of the elevators from previous year's stocks and how does that play out in terms of timing over the next several months or quarters?

Tom Hund

That's a little tough to tell as well. We don't know exactly what stock goes into an individual train, but we assume that first in, first out to a great extent, but we are starting to see some movement of grain. The harvest was delayed significantly particularly the corn harvest because of one, a very cool summer that just delayed the germination and now we are having a lot of wet conditions up north which is delaying the harvest as well. But there appears to be good, solid demand for whole grains particularly on the export side.

Operator

We will go to Bill Greene with Morgan Stanley.

Bill Greene - Morgan Stanley

Matt, as you look at the industry volumes and we look at kind of where the industry is running in the third quarter and we look just assuming even normal seasonality, it seems that we should be able to get above flat in 2010 for the industry on either a ton mile or even on a carload basis. Does that sort of foot with how you think about what the recovery should look like?

Matt Rose

Bill, I think it's more instructive to look at it, not an aggregate, but by breaking the quarters and the two parts of the year because if you think about rail volumes, we saw kind of three steps about a year ago literally, third week of October, we took the first step. The second step was in the first quarter and the third step was in the second quarter, mid-second quarter. So I think if you think about these year-over-year comps, certainly it's still going to be very difficult in the first quarter and it will mitigate some in the second quarter and then third and fourth are just going to be easier. And then the question is going to be what kind of economy do we have to put on top of that?

Bill Greene - Morgan Stanley

So when you were referencing we just need volume growth and so we will be just fine, was that a reference to pricing or that you'll be just fine on where you can get on price or what was that in reference to exactly?

Matt Rose

It's just that more volume and it will help our ability to offset our inflationary pricing. I mean, it is a simple concept of greater excess capacity is going to put more pressure on price, specifically on the truck, competitive type moves. And so if we start to see gross ton miles come back to the railroad and start to fill up some of this capacity, then you'll see the LTL guys and you'll see the domestic guys, domestic truckload guys start being able to price up and when that happens we'll have more flexibility.

Bill Greene - Morgan Stanley

And when you think about productivity and what you can keep since you've demonstrated such good cost cutting on the way down, why should we assume that you can actually get that much leverage on the way back up?

Matt Rose

You learn a lot when you have these falling volumes and as I said in my comments and as Carl said in his comments that we expect there will be more leverage on the way up but that's yet to be proven, but we just believe that the same productivity initiatives that we've had to deal with in this time, we will carry those up with us. So we will see.

Operator

The next we have Ed Wolfe with Wolfe Research.

Ed Wolfe - Wolfe Research

Just on the pricing side again, I think John said that 80% of the 60% of what's going to be priced is locked in. Can you talk about on the recent stuff your pricing, how that feels relative to six months ago or nine months ago?

Tom Hund

No, we don't get into individual discussions particularly at any point in time because things are so different on a customer-by-customer basis, Ed.

Ed Wolfe - Wolfe Research

Do you have an average of kind of what those are pricing at relative to the 3% that you noted?

Tom Hund

No.

Ed Wolfe - Wolfe Research

The 3% exclusive of RCAF that you noted, how does that compare to a year ago and the last couple of quarters?

Tom Hund

It's a little bit less obviously. I mean, the numbers that we reported the last several quarters and a year ago were better than that.

Ed Wolfe - Wolfe Research

When you look out at where pricing pressure is coming from, we’ve spent a lot of time talking about domestic intermodal. What other areas are relatively stronger than the average and what after domestic intermodal is something that's not quite as strong in terms of segments?

Matt Rose

Ed, I think if you just look at it on a continuum of all the stuff that’s truck and truck-like, whether it's a load of lumber on a center beam that can go on a flatbed or it’s paper that can go on a box car, on a truck. Great excess truck capacity is hard and that's what we are seeing and in the trucking industry it just depends on the business and depends on where we are at in the cycle.

But clearly the excess truck capacity is well written about by people like you. And it is continuum of the portion of the business that floats in and out of trucking into railroads. And that stuff is going to be the hardest for us to continue to be out-pricing.

Ed Wolfe - Wolfe Research

In terms of international intermodal contracts, what percentage of that book comes up for bid in 2010 and what percentage you should give or take in 2011?

Matt Rose

There is no big contracts coming due in 2010. And we might have one or two in ‘11. I would have to look at that. But it’ll be no more than a couple at the most.

Ed Wolfe - Wolfe Research

A clarification on what Tom said before. The lower expense credits of $0.10 stamp benefit, can you talk about what that was?

Tom Hund

Capitalized overheads of the work programs. It’s $0.10 but in spirit here, this is a good issue for us. We got the work done earlier and our actual cost per units of getting that work done is very favorable. That's the way the accounting treatment handles it on this. But, we have had a very good year in terms of getting our capitalized work done at a very favorable cost to the tune of a five-year all-time low.

Operator

We have a question from Randy Cousins with BMO Capital Markets.

Randy Cousins - BMO Capital Markets

Just coming back to the intermodal. Again, you had a major contract shift from your cells to another railroad. When you look at your domestic intermodal, both year-over-year and quarter-to-quarter, could you guys give us some sense as to sort of what the actual change was in the domestic intermodal business?

Tom Hund

Domestic intermodal reported a 33% decline in revenue on a 17% decrease in units.

Randy Cousins - BMO Capital Markets

Yes. But if you exit the hub business, what did it look like?

Matt Rose

We would have to get back to you on that, Randy. We are not going to start carving out Hub and then Hunt, it is what it is.

Randy Cousins - BMO Capital Markets

What I really want to get at is, you do have a huge amount of competition from the trucking industry. But are you losing share or taking share from the truckers given your improvement in your service offerings, your competitive advantage on fuel?

Matt Rose

Look, the trucking industry is clearly in desperate straits right now and we hear on a daily basis just how low they are willing to go to move that incremental truck. So, I would say that everybody is kind of pulling their own from a market share standpoint right now.

Randy Cousins - BMO Capital Markets

Second question is PNW versus the Gulf. Obviously it tends to be better for your Ag business if it ships or notionally I always have had the sense that it’s better for your Ag business if it ships out through the PNW? Could you speak about sort of relative trends in terms of sort of where the Ag product is moving to and where you see it moving to in terms of sort of exit port?

Matt Rose

We like both lanes. The PNW and the Gulf and we see increased volumes going in both directions right now.

Randy Cousins - BMO Capital Markets

You don't have a preference whether it’s down to the PNW or through the Gulf?

Matt Rose

No, we do care. We would rather see it go to the PNW. The ocean spreads are enough, they still ought to help us modestly to go to the PNW.

Randy Cousins - BMO Capital Markets

Okay. So right now it favors the PNW but not hugely?

Matt Rose

Correct.

Operator

The next is Matt Troy with Citigroup.

Matt Troy - Citigroup

A question for you, Matt and Tom, if you guys strip out and look at two economic returns, you guys have been among the best in the industry. Just being interested in your thoughts, given the volume environment, we are going to end the year down somewhere in the low to mid-teens which is a structural decline and if I look at expectations, people are looking for low single-digit, mid single-digit volume recovery for the next couple of years.

I know it’s going to take a couple years to get back to where we were. I was just wondering if you could help me in terms of your capital program. Might you be rethinking some growth projects or investment and might you be rethinking some of the return criteria. How you just frame the investment decision?

Matt Rose

So all of the growth stuff, we will cease and desist on anything that’s not already started. So we’ve got a lot of capacity as you mentioned in your question and so we won't need the growth capital.

So normally what you would see is a reasonable reduction from that growth capital which runs from $200 million to $400 million a year. We do have this train control technology, PTC capital that’s going to eat up some of the savings on that. But, we’ll see how all that works out in terms of the ultimate cost on it. So, literally we have got a couple of expansion projects that we will conclude, but there is none that's going to be started I think for several years.

Tom Hund

You actually see that in this year's capital number. The 26 which is down from last year's 2850. 60% of the 250 is related to reduction of expansion capital to get it down to a very small number this year. As Matt said just sort of keeping the projects that exist and we have (inaudible) et cetera going. And then the rest of it is due, maybe $100 million or so is due to being more efficient and the overall maintenance program. But I think we see it this year already and you'll see it even further into the future.

Matt Troy - Citigroup

Is it reasonable to assume or even ask the question, it is kind of a low growth, long-drawn out recovery that the maintenance component of your capital might come in a bit as well or are we thinking about into short term?

Tom Hund

Our maintenance capital is really reflective of gross ton miles growth or lack thereof over the time. You will see less pressure on the units and then we will have to see what kind of inflationary environment that we have with the actual components of the maintenance capital. So that’s - I mean it's a fair way to look at it. We just don't know -- you tell me what the price of a tie is going to do over the next three years and I'll tell you whether or not our total maintenance capital is going to come down or not.

Matt Troy - Citigroup

If you [parched] the port data looking at exports you've got some folks out there talking about a structural bare case for the US dollar. Are you seeing any kind of change in direction of freight flows, kind of west coast outbound? Are you hearing from customers about new opportunities or enquiry about capacity to go the other way? Are we really still dealing the theoretical at this point.

John Lanigan

We're still largely in the theoretical. We are seeing some increase in exports but it's really more in discussion than it is in reality at this point.

Matt Rose

But the other reality, though, is if the consumer came back in, it doesn't matter how far the dollar drops, there is only one place that most of this stuff is made now, the stuff that everybody buys at the retailers and that's Asia and China. We talk about lower dollar as a structural barrier to imports. There is no other source. And so it's much more important for us that the consumer comes back, then what the price of the dollar is going to be. Lower dollar is going to help us on the exports. There is just no doubt about that.

Matt Troy - Citigroup

It could actually be an incremental and marginal positive and that you have a more balanced freight flow, if more stuff is heading the other way.

Matt Rose

The only problem is that the two types of conveyances typically aren't the same. We're usually shipping out in bulk and coming in, in containers.

Operator

Next is Gary Chase with Barclays Capital.

Gary Chase - Barclays Capital

John, wondered if you could shed a little light on what's going on from a pricing perspective in the tariff areas? If you could just comment on what's happening? I know significant components of the Ag and industrial businesses, have those been outperforming that 3% x RCAF you're talking about or kind of in line?

John Lanigan

They are more or less in line.

Gary Chase - Barclays Capital

Wanted to switch gears to for, Carl. You noted in one of your slides there about train length moving up, not being what you would expect in this kind of volume environment. Does that affect in any way the opportunity to continue driving that metric looking forward as volumes do recover?

Carl Ice

I may have misspoke. What I was trying to say was that when you're pushing train links up when volume is down, it's a barrier against it lowering well. But despite that we did lower our cart well. So we will continue to expect to drive increase in train size.

Gary Chase - Barclays Capital

And you would think in a better volume environment that should pick up, right?

Carl Ice

I think the opportunities are there but, again, we have driven improvement in this environment too. I mean, driving train size helps one with density, but we always vary our train network based on the volume it needs to handle.

Operator

We will go to Jason Seidl with Dahlman Rose.

Jason Seidl -- Dahlman Rose

Couple of quick questions. One on PTC. Could you give us what you think your total cost is and over how many years it might be spread out?

Matt Rose

We don't know yet because we have got to wait until the FRA finalizes a rule making because that will determine the scope of the implementation. But I think you could definitely get in the realm of things somewhere between $1.3 billion and $1.8 billion for us and it’s five or six years.

Jason Seidl -- Dahlman Rose

Matt, if we could just touch a little bit on Washington. We've been hearing chatter, the bill is coming, but could you talk just in general your view of sort of how the bill might shape out in terms of being favorable, neutral or unfavorable to the rail industry?

Matt Rose

So the reason you keep hearing 'the bill is coming' is because a lot of people spent a lot of time working on it, the senate and commerce staff to the [chipper] trade groups to the railroads. And the reason why the bill hasn't come is because this is a very difficult issue. And I think the one thing that we can all feel very good about is that Senator Rockefeller, I'm sure he is not spending every day looking at this. He is worried about healthcare and other things. He has been incredibly thoughtful in terms of finding the right balance to address some of the customer concerns, but also to make sure that his broader agenda can be fulfilled and that is more rail, more rail investments, more rail, so carbon can be reduced from the environment and more rail so we can reduce our dependency on foreign oil.

And I think just the time has been very reflective for people to have to really debate these issues and to really understand the tradeoffs of any negative impact to the railroad and what it does to future investments. And so that's why there hasn't been in my mind a bill released and I haven't talked to Senator Rockefeller about this for a little while. So we don't know when the bill is going to release and we don't know what it will look like, but we do know that there is an awful lot of consideration and an awful lot of thought going into this.

Operator

We will go to Chris Ceraso with Credit Suisse.

Chris Ceraso -- Credit Suisse

I don't want to get too picky on this, but you walked us through very helpfully on how we got to the $1.20 number versus the Q3. What bridges the difference there between the $1.10? What's the variability? Are you expecting more pressure from fuel and RCAF? Is it volume that's going to be a bit seasonally softer from three to four? What accounts for the spread there?

Matt Rose

We mentioned a couple of other factors and I think there's probably three. One is you don't know which way it's going to go, and two are negative. One is the impact of winter. We don't know what the winter is going to be like, but we do know in the fourth quarter, for instance, things like fuel efficiency definitely deteriorates as you're trying to deal with the winter and you're not able to shut down as often and things like that, locomotives, et cetera.

Then velocity clearly begins to deteriorate a little bit too typically because of the weather. So both of those -- that's one thing that becomes negative. The second is we normally have a little bit of a seasonal downturn at Christmas. The last week if not more of the quarter with very, very low volumes for that period of time and obviously we have 13 weeks in the quarter. That places some pressure on it. And the last one is just what happens with volumes and that one could be plus or minus, but the first two clearly are a negative impact offset by whatever else we do on the positive side.

Chris Ceraso -- Credit Suisse

Do you have an underlying assumption on volume? Are you expecting it to be flat or better?

Matt Rose

Well, as I mentioned before it's trending thus far into the quarter similar to the third quarter but what we always know as we get a downtick around Thanksgiving and then that whole week of Christmas is usually a downtick as well, so unless it goes counter to that then we would anticipate the volumes would be slightly lower in the fourth quarter than the third quarter.

Chris Ceraso -- Credit Suisse

Will fuel creeping up here help pricing in the intermodal business or do you need volume?

Matt Rose

You really need volume for all of our businesses. Fuel would help from a standpoint of the overall comparison to trucking and the value that we bring to the customer from an overall cost perspective. But volume as Matt said before is really the prime driver behind filling up our capacity and making us even more valuable asset to our customers.

John Lanigan

And most of the trucking contracts are on a year basis, so a quarterly increase or dip doesn't really affect us that much. There's not that much spot truckload business.

Operator

Next we have Walter Spracklin with RBC Capital Markets.

Walter Spracklin - RBC Capital Markets

On the trucking, I heard lots of theories about what fixes the capacity or overcapacity issue. I’d like to hear your thoughts particularly whether you see it as a supply side fix or a demand side fix. You mentioned volume has to come back. That will help obviously. But fuel is creeping back up here again. Obviously you are a lot more competitive there. Is that something that’s going to force capacity in the trucking system down and are you seeing any signs of that? Just your take on how the capacity in the trucking sector develops over the next three to six months?

Matt Rose

Certainly fuel going up is helpful to us in our story. But the real issue is the banks have to start taking back the trucks whose payments aren't being made on and we’ve heard from a number of trucking companies there is a significant amount of capacity that is basically running out there for variable cost because the banks want to get a truck back just as much as they want to get a house back and they are telling a lot of these trucking companies, just send us what you can and we will get back with you later. They are not repossessing the trucks.

The bank is getting back into the game of doing what they would normally do during a recession which we’ve seen in every other recession which is repossessing trucks will be part of the answer as volume comes back and as the banking system gets healthier et cetera.

Walter Spracklin - RBC Capital Markets

So asset prices have to come back, but arguably when that comes back to the whole volume have to improve and demand for truck assets has to go up to begin with anyway?

Matt Rose

Yes. It’s all interrelated with just the economy coming back.

Operator

Next we have Justin Yagerman with Deutsche Bank.

Justin Yagerman - Deutsche Bank

Looking at pricing and it’s been talked about a bit, but thinking about at 2%, that maybe above inflation now but on a go-forward basis probably isn't. Or right around inflation now. I mean, what are you guys thinking, is it durable range as you look out, that we should be thinking about for pricing and then I guess if it’s not achievable above that range, where does maintenance CapEx start to come in at over the next several years and thinking about how you invest in your business?

Matt Rose

Yes. So, we’ve said that we need to exceed inflation. We are sticking to it. It’s really important for our company and this to be able to do that because of the capitalized maintenance that we have and certainly given any sort of economy at all, we don't see that to be an issue.

Tom Hund

And Justin, I think I want to make sure that we are clear. The 2% price included the RCAF fuel and when you take the RCAF fuel out, it’s 3%. We really think that’s more of an apples-to-apples price comparison.

Justin Yagerman - Deutsche Bank

Then you spent time talking about fuel hedging and just a clarification and then a question. When you said the $0.20 drag number, was that for Q4 or was that for the full year in '09? And then, when you look at the directionality of fuel heading into 2010, how does your hedging line up with that? And if we see a spike in fuel is that going to work for or against you guys when you think about how that hedge is in place?

Tom Hund

The $0.20 is just a Q4 number and it’s heavily driven by the lag benefit that last year's fourth quarter had. So that's a year-over-year. Then if we look at our hedges, we will file our 10-Q tomorrow. And, I mean we give five pages of detail in there on hedges. So you'll be able to actually do the calculation.

But generally speaking the hedges we have going forward, some are in the money, some are out, but not in a material way, either way. At the present time, obviously rising fuel price is purely isolated on hedging will cause those that are out of the money to get in the money and those that are in to be even further in. But you have the moving parts and fuel price goes up, fuel surcharge goes up and you look at all three in concert with one another.

Operator

Next we have Donald Broughton with Avondale Partners

Donald Broughton - Avondale Partners

What were fully diluted shares for the quarter?

Tom Hund

It is about 343.

Donald Broughton - Avondale Partners

About 343? And interest expense, there’s a lot of moving pieces there. I know in the second quarter you had given guidance on the 137, we’re seeing a benefit nonrecurring of $10 million. So, I’ve gone in for a $147. Any kind of a range on which you think interest expense will end up within the fourth quarter?

Tom Hund

It’s a 150 and this quarter has about 15 million of unusual favorable interest adjustments principally related to some tax settlements that we had come through.

Operator

That does conclude our Q&A session. Mr. Rose, do you have any closing remarks?

Matt Rose

No. Everybody go out and buy some stuff at Wal-Mart, Target, Home Depot, Lowe’s. And we appreciate your interest. We’ll talk to you next quarter. Thank you very much.

Operator

Thank you then. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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Source: Burlington Northern Santa Fe Corp. Q3 2009 Earnings Call Transcript
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