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Union Pacific Corp. (NYSE:UNP)

Q1 2010 Earnings Call

April 22, 2010 08:45 am ET

Executives

Jim Young - Chairman, President and CEO

Jack Koraleski - EVP Marketing and Sales

Dennis Duffy - Vice Chairman Operations

Rob Knight - EVP and CFO

Analysts

Matt Troy - Citigroup

Tom Wadewitz – JPMorgan

Jon Langenfeld - Robert W Baird

Chris Ceraso – Credit Suisse Group

Bill Greene - Morgan Stanley

Jason Seidl - Dahlman Rose

Walter Spracklin - RBC Capital Markets

Justin Yagerman - Deutsche Bank

Ken Hoexter - Bank of America/Merrill Lynch

Tom Marsico - Marsico Capital Scott Malat - Goldman Sachs

Chris Wetherbee - FBR Capital Markets

John Larkin - Stifel Nicolaus

Jeff Kauffman - Sterne Agee

Operator

Greetings and welcome to the Union Pacific First Quarter 2010 earnings. At this time all participants are in a listen-only mode. A brief question-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded and the slides for today’s presentation are available on Union Pacific’s website. It is now my pleasure to introduce your host, Mr. Jim Young, Chairman and CEO for Union Pacific. Thank you Mr. Young you may begin.

Jim Young

Good morning everyone. Welcome to Union Pacific’s first quarter earnings conference call. With me in Omaha today are Dennis Duffy, Vice Chairman Operations; Jack Koraleski, Executive Vice President of Marketing and Sales and Rob Knight our CFO.

We are starting off 2010 with a record quarterly performance as earnings grew 40% to a first quarter record of $1.01 per share. This includes the one time cost impact of the announced CSXI deal which totaled roughly $0.06 per share. Rob will give you more details on that when he discusses the financials.

A major contributor to the year-over-year gain was a 13% volume increase, our first quarter of color growth in two years. Jack will provide commentary on the volume picture but we clearly saw a pick up in demand across the networks.

For example, although coming off of a low base in 2009, steel, lumber, soda ash and fertilizer all experienced solid quarterly growth. Equally important to our quarterly results was the volume leverage we generated by running a safe service focused efficient operation. We’re utilizing our capital investments, technology and productivity enhancements to move increased car loadings with fewer resources.

Strong service levels continued to deliver value for our customers which also supported our pricing gain and attracted new customers to the rail road. The net results of increased volumes, solid pricing and operating efficiency was a record first quarter operating ratio of 75.1. This achievement is consistent with our commitment to significant leverage any volume growth in our network. Operating income was also a record totaling $988 million up 47% for 2009.

Our record financial performance enabled us to achieve strong free cash flow after dividends in the first quarter further demonstrating the power of our operating leverage and the great UP franchise. Now we’ll hear from Jack with a discussion about our volume growth. Jack.

Jack Koraleski

Thanks Jim and good morning. Over the more stable economy of the first quarter marked the long awaited swing back to volume growth. Against last year’s recession impacted business levels, our volume grew 13% with five of our six businesses posting gains. Energy was slightly down, they were the lone exception. Average revenue per car increased 3% with core pricing gains of 3.5% and higher fuel surcharge revenue partially offset by some negative mix that was largely the result of volume growth in intermodal.

Negative pricing in intermodal, that’s the lingering effect of domestic legacy contracts that have now been replaced. Once again impacted overall price performance and produced what will be our weakest reported price gains in 2010.

The growth in volume and increased revenue per car combined to drive freight revenue up to 16% to $3.8 billion with each of the six businesses posting revenue gains. So, let’s take a more detailed look at each of the six groups.

Agricultural products revenue grew 10% as 8% growth in volume combined with a 3% improvement in average revenue per car. Whole grain export car loads increased 28% led by a near doubling of weak shipments through gulf ports.

The continued impact of damaged South American crops last year boosted soybean export 13% and also drove a 48% increase in soybean meal exports. Our ethanol shipments grew 28% as the federal mandate ramped up and California blending increased and DDGs also saw a continued growth with volumes up 15% in the quarter.

Automotive revenue increased 88% as a 21% improvement in average revenue per car combined with a solid increase in shipments. Volume was up 56% from last year when the auto industry was struggling with high inventory levels of sales swamps. Average revenue per car received a boost from the renewal of the last auto’s legacy contract as well as some other contract increases.

Increased production and sales was reflected in growth for all manufacturers with vehicle shipments increasing 67% and our parts volume growing 42%. Our chemical revenue grew 14% as volume climbed 13% and average revenue per car was up 2%. Fertilizer and industrial chemicals were the primary drivers of the volume growth although car loadings were up in all major chemical markets.

After a couple of disappointing seasons, our fertilizer shipments grew 39% with a 126% increase in export potash leading the way. Compared to a weak first quarter a year ago, a modest increase in demand coupled with a more balanced inventory level position produced a 14% increase in our industrial chemicals business. Soda ash volume grew 19% as both export and domestic demand increased and LPG shipments were up 16% and plastic volumes were up 4%.

Turning to energy, while stronger economic activity increased electrical demand, it wasn’t enough to drive year-over-year growth in energy where volume decreased a little less than 1%. However a 6% improvement in average revenue per car produced a 5% increase in revenue.

The trend out of the Powder River Basin was encouraging posting year-over-year increases in February and March after running below 2009 levels in January but finished up 1% for the quarter.

Our Colorado Utah tonnage was down 4% as high stockpiles curtailed shipments for a few large customers. Franchise productivity improvements continued in both markets and if you flip to the next slide we can talk for a second about coal stockpiles.

Drawn on this graph is the monthly coal stockpile data for the Powder River Basin. The grey line shows you normal stock in terms of normal days of burn, the blue line shows how stocks are actually tracking. The most recent data available is for February, but you can see how sharply the severe winter weather cut in the coal stock piles, dropping the Powder River Basin stockpiles to 59 days of burn, compared to what would be a more normal level of 52 days.

I suspect that when the March report comes out its going to show continued improvement as well. A more stable economy, a pick up in industrial production particularly in energy sensitive industries like steel, improvement in the export market for coal as world wide demand increases and the reduction of stockpiles are all encouraging things for the coal business so, if we have normal summer burn our coal business could actually strengthen as the year progresses.

Industrial products line grew 9%; it’s the first year-over-year growth since the first quarter of 2006. Revenue grew 10% as the volume increased combined with a 1% improvement in average revenue per car.

Average revenue per car was impacted by the significant growth of our uranium tailing shipment for the department of energy. The volume for the short home (inaudible) was 450%. Improvement in the automotive industry and energy drilling as well as restocking by metal service centers pushed steel mill capacity utilization to 68% in the first quarter that was up from 43% a year-ago.

That improvement was reflected in a 28% increase in our steel and scrap business. Increased drilling activity also helped drive a 20% increase in non-metallic minerals with growth and frac sand shipments. And although our lumber business grew 8%, we are still looking for some real significant signs of recovery in our cement, rock businesses both of which declined largely a reflection of a lack of demand tight credit and shrinking spate in the local budgets.

Intermodal revenue increased 25% as a 21% increase in volume combined with a 4% improvement and average revenue per unit. While Intermodal pricing should improve as new contracts take affect, I would remind you that the benefits of the new Pacer arrangement are phased in between and the original contract expiration.

Further more some of that benefit will be in the form of field surcharge recovery which still results an improved margins, but it’s not reflected in our core price calculations.

Improved consumer demand and inventory restocking led to a 12% increase in our international Intermodal volume. Domestic Intermodal volume grew 33% aided not only by an improved economy, but also by business converted from the highway and our year-over-year growth with hub.

Our streamline subsidiary door-to-door product grew 77% in volume with almost half of that growth coming of highway conversions. Also during the quarter we announced the creation of the new UMAX container program. The new UMAXs program replaces our own CSXI legacy contract and it strengthens our domestic Intermodal value proposition, better positioning us for highway conversions and other growth opportunity.

Like the Pacer deal last fall, the CSXI renegotiation was pulled ahead and with its completion there are no remaining legacy contract in our domestic Intermodal business. This is significant because it allows us to work directly with the majority of our Intermodal customers.

The new UMAXs program provides those customers with access to more than 20,000 containers an expanded market reach across North America with over 600 service lanes supported by faster and more frequent train schedule.

Our Intermodal franchise positions us to offer the most complete coverage of domestic Intermodal lanes and our strategic investments and process improvements that support excellent service allowed us to improve our transit time in 60 of those lanes during the first quarter. And the good news is it’s only going to get better when we open our new Joliet Intermodal Terminal late this summer. The new facility will increase both of our international and domestic capacity, it will improve our efficiency and it will further strengthen our Intermodal value proposition.

Without question customers have come to except the higher level performance from us, so we are pleased that customer satisfaction stayed strong, coming in at 87, matching last years score. As we continue to offer strong value proposition underpinned by excellent service and backed up with strategic investment from a strong customer relationship.

So let me wrap up with a look at where we are. A more stable economy has produced a stronger run rate so far this year an external forecast predict continued year-over-year improvement in key areas like industrial production, imports and exports. Since the beginning of the year, the outlook for vehicle sales has strengthened but the projection for housing starts has weakened a bit. Taken all together, we think the economy is going to stay the course as we looked ahead of the second quarter and beyond to the rest of the year.

A continued slow recovery will likely keep our business stronger than last year, but below the levels that we’ve seen in the past. It is a look at some of the drivers that we see for each of our businesses in the second quarter.

In Ag the South American grain harvest and normal seasonality have already begun to soften grain export volumes. Although, we may see some recovery later in the year with the North American harvest exports could run below 2009 level.

Providing some offset the federal mandate and increased lending in California should drive continued growth in ethanol and DDTs. Obviously the second quarter last year was a tough time for the automotive industry, expectations this year are for significantly stronger production and sales levels and the external forecast projects strengthening through the year. Apart from the anticipated seasonal slow down of fertilizer, demand in most of our chemical market should remain stable.

In terms of energy, increased industrial production should spur further recovery in electrical demand and our Southern Powder River Basin business will also benefit from the startup of the new unit at San Antonio during the quarter. Colorado, Utah volumes were expected to be about flat for the year, but should post growth against last year’s coal quality in production challenge second quarter.

Continued strength in the auto industry and drilling activity should translate in to growth and steel and non-metallic minerals and we are watching for some signs [in-light] from that construction area as we move into the second quarter seasonal ramp up in construction activity.

International Intermodal should benefit from stronger imports while a strong value proposition should continue to attract highway conversions to our domestic Intermodal business. We’ll also benefit from the shift of the hub business.

Our strong value proposition not just in domestic Intermodal but across to all our businesses will allow us to take advantage of the opportunities that arise if the economy that recovers. Stronger economy should be good for pricing which along with excellent service, strategic investments and innovative product offerings will drive a stronger price plan over the balance of 2010. Although it’s still early in the quarter we’ve already seen price up about a point versus our first quarter.

So with that, I will turn it over to Dennis for the operations report.

Dennis Duffy

Thank you, Jack and good morning. With volume growth starting to return, we operated a safe and efficient [rail road] that continue to deliver the quality service customers have come to expect from Union Pacific.

First quarter 2010 metrics illustrate that performance. Starting with safety, both employee incidents and great crossing accidents were at record first quarter lows. Our internal service measure, the service delivering index at 89 is close to last year’s record mark of 92. In fact, we tightened the windows around our service commitments beginning in the second quarter of last. So the 89 was achieved against a higher standard.

On a more apples-to-apples basis, we would have been closer to 93 without the reset. This illustrates how as we take variability out of the network, we are holding ourselves to a more rigorous service standard and delivering consistently better service to our customers.

Although velocity decline mile per hour year-over-year much of the decline related to the winter weather and an aggressive engineering program on the Sunset Corridor and across large portions of our single track rail rod in South.

Importantly running a safe fluid rail road generated excellent operating leverage in the quarter as evidenced by volumes increasing 13%, while through freight train starts increased only 1% and yard and local starts actually decreased 7%.

Our core track infrastructure is built to handle a 190,000 to 200,000 weekly car loads. So with today’s volume running around 170, we have capacity for growth. We are also creating capacity to an evergreen approach to improvement. A key fundamental component of this is inventory management.

First quarter freight car inventory declined 3% versus 2009. With this productivity improvement, we handled 235,000 more carloads in first quarter 2010 with nearly 9,000 fewer cars versus first Q’09. Train design efforts are helping us maximum throughput across our network, this work in combination with greater utilization of locomotive technologies such as distributed pair, enable us a significantly increased train link.

For example, in the first quarter we achieved a 15% increase in our Intermodal train size saving roughly 900 Intermodal train starts. Locomotive technology also drives better productivity and lower fuel consumption. Additionally our engineers play a key role in conservation. Through our fuel masters’ unlimited program which shares some of the company’s cost savings with the employees, we are seeing continuous improvements in our consumption rate again, setting us a new first quarter record.

We are also ready with the necessary working resources to handle the growth. We have recalled about 1600 employees so far in 2010 bringing furloughs down to around 2800 remaining. Our retention rate remains nearly 90%, which is very good considering most of these folks haven’t worked for a year or more.

We are anxious to get everyone back to work and are even using voluntary transfers to relocate employees to areas where additional crew resources are needed. This is a win-win, saving hiring and training cost for the company and putting a paycheck back in the hand’s of the employee sooner. We anticipate additional engineer training and transfers in 2010, the extent to which will depend on volume return. While it has placed some locomotives and freight cars back in the service, we still have a good supply and storage. Beyond having the available resources, improved utilization is essential to delivering on our volume leverage opportunities. We are seeing productivity gains across the board; in particular freight car utilization was a first quarter best.

So, going forward the key for the operating team continues to be agility. We have to be prepared to meet and beat customer expectations regardless of what happens with volumes. To that end, we follow the principles that have driven our improvement, focusing on safety, hardening the infrastructure thus reducing operational variability. Efficiently leveraging the network volume and delivering excellent service and creating value for our customers.

With that, I’ll turn it over to Rob to discuss the financial.

Rob Knight

Thank you Dennis and good morning. Before we go through UP’s record first quarter earning, I’d like to make everyone aware that the 2009 fact book is now available on the UP website under the Investor’s tab. So please feel free to check that out.

Slide 21 summarizes our first quarter results with operating revenues up 16% to nearly $4 billion, driven by double digital volume growth, increased fuel surcharge revenue and pricing gain. Operating expenses increased only 8% to $3 billion demonstrating great operating leverage. This leverage is especially evident when you consider the fact that higher year-over-year diesel fuel prices accounted for nearly 75% of our quarterly cost increases.

Quarterly operating expenses also included a one time payment of $45 million to CSXI as part of the transactions restructure our Intermodal transportation relationship. As Jim mentioned, that payment subtracted roughly $0.06 from our quarterly earnings.

Operating income totaled $988 million, a first quarter record and a gain of 47%. First quarter other income was only $1 million as we incurred roughly $16 million in early debt redemption cost plus higher environmental remediation charges.

Interest expense at a $155 million, was up $14 million year-over-year, primarily as a result of higher debt levels. Our effective tax rate was 38.1%, 3.6 points above the 2009 first quarter rate of 34.5%. You might recall that last year’s rate was lower as a result of a newly enacted state tax legislation.

Taken together, first quarter net income totaled $516 million or earnings of a $1.1 per share, up 43% and 40% respectively. On the pricing front, we are reporting core pricing gains of roughly 3.5% in the first quarter. That number includes about a 0.5 point related to the year-over-year increase in RCAF fuel escalators. We recognized that consistent core price improvements are critical to improving our overall returns and we are committed to that task. Importantly, with the economy turning around, our continued strong service offerings as well as the re-pricing of some major legacy deals, we believe pricing will improve over the balance of the year.

In other words, we believe the first quarter of 2010 price numbers should mark the low price point for the year. Our legacy renewals also provide us with better fuel cost recovery. And although this does not contribute to our core price numbers, it definitely improves our Intermodal and overall company margins.

Let’s look at the expense side now, starting with compensation of benefits at $1.1 billion in the first quarter, a 1% decrease versus 2009. Although car load volumes grew nearly 13% in the first quarter, UP’s work force levels actually decreased 6% versus 2009.

As you might recall, volumes fell off very quickly last year, leaving us to play catch up as we worked to align our resource levels with demands. To now put this in perspective, slide 23 shows both first quarters seven day car load volumes as well as our employment levels between 2008 and 2010.

With volumes [off] 10% over the two year period, employment levels were down 14% as we increased productivity in all areas of the business. Labor productivity can be measured several ways, but the common measure of gross tonne miles per employee increased an impressive 16% in the first quarter of 2010, versus 2009. Offsetting some of our productivity gains where higher cost per employee driven primarily as a result of the agreement side of last year’s 4.5% wage increase, as well as health and welfare inflation.

Going forward, we’ll continue recalling employees if need to back fill attrition and handle business volumes.

As we’ve said before however, this won’t be on a one-for-one basis as we expect offset some of those needs with continued productivity. First quarter fuel expense increased 51% to $583 million as a result of higher year-over-year diesel fuel prices and increased tonnage moving across the network. First quarter prices averaged $2.16 per gallon, a 43% increase from 2009’s $1.51 per gallon. Although increased diesel fuel prices added a $171 million to our quarterly expenses, we offset roughly $14 million through greater fuel efficiency.

Turning now to slide 25, we summarize the year-over-year change in three of our expense categories. Starting on the left with purchase services and material, this expense increased 7% in the quarter to $432 million.

Increased volumes led to greater contract service expense in areas such as Intermodal ramp operations and purchased transportation. Offsetting a portion of that increase was less material usage associated with fewer locomotive and break car repairs. We should also notice slight change in the amounts reported as purchase services and materials expense for 2008 and 2009.

As we reported in the 10-K we changed our accounting policy for rail grinding cost in the first quarter of 2010 from a capitalization to a direct expense method. We will show this change with respectively in the quarterly earnings releases and SEC filing.

The annual impact of this change is very small affecting only a couple of expense lines and totaling a penny for all of 2009, but there are some minor differences, so please be aware of this change.

Equipments and other rents expense decreased $27 million or 9% in the quarter. As discussed previously $22 million of the decline is associated with the locomotive leases restructured in the second quarter of 2009. Expenses were also lower in the quarter as a result of fewer leased break cars and Intermodal containers. We did however see an increase in short term car rents versus last year as both automotive and Intermodal volumes made very strong gain.

Other expenses grew $20 million in the first quarter to $246 million an increase of 9% the biggest driver was the $45 million one time payment to CSXI.

Reduced quarterly personal injury expenses related to our ongoing safety improvement and lower bad debt expense helped offset a portion of this increase. With volumes running higher year-over-year and excluding the $45 million payment, the run-rate for other expense should be more in the neighborhood of $200 million per quarter. The key first quarter’s storyline was the tremendous operating leverage generated from the volume growth, slide 26 illustrates that and while our business volumes increased 13% in the first quarter, operating expenses only increase 2%

On this chart we have normalized 2010 operating expenses to reflect the year-over-year change in diesel fuel prices which illustrates that we are only about 20% expense variable in the quarter.

In 2009, we were about 80% variable in a declining volume environment, but as volumes increased you want to reverse that map rolling volumes faster than cost and we did just that. Although, we are very early in the recovery cycle, we are clearly enjoying the leverage associated with adding cars to existing trains improving the utilization of our locomotive and freight car fleet as well as increasing employee productivity

Going forward it will be a challenge to add volumes faster than cost, cost will necessarily comeback in a linear fashion, so we’ll likely see some step functions depending on how the volume actually returns. Over all though, we believe that roughly a third of the cost reductions that we achieved last year should be permanent. The strong efficiency illustrated by our operating expense variability is also reflected in non-operating ratio which was a first quarter record at 75.1%. We achieved 5.3 points of improvement versus 2009 more than offsetting the headwind created by higher diesel fuel prices and the CSXI payment which together impacted our operating ratio by about four point.

The ongoing efforts of project operating ratio strong volume leverage, continued operating efficiency and core pricing gains all contributed to this record mark. Solid quarterly financials carried over to both our cash flows and balance sheet. On the cash side we achieved free cash flow after dividends of $426 million. This is a substantial increase versus 2009 and is principally driven by improved first quarter earnings, lower cash tax payments versus 2009 and the timing of payments for some capital equipment.

We also continue to have a very strong balance sheet with our adjusted debts to Cap solidly in the mid-40s range. This balance sheet metrics supports our goals of maintaining a solid investment of great credit ratings.

With a record first quarter in the books, let’s look ahead at the second quarter. The primary driver of our quarterly earnings will be volumes, and as Jack discussed earlier, we are seeing stronger year-over-year demand. As you recall the second quarter 2009 was the low point for our seven day car loading volumes which came in a little over a 143,000.

Although we aren’t giving specific volume guidance, at the current run rate we could again see double digit gains. With the continued car load growth, we would expect to generate solid volume leverage. The comparison will get tougher however, as we move through the year.

We took cost out of the systems throughout 2009, becoming more and more aggressive as the months passed without any economic improvement. We’ll also face the added pressure of agreement, wage and benefit inflation. As we previously discussed health and welfare expenses are driving cost higher in 2010. We don’t accept this as an excuse however and we will continue to work to offset a portion of this increase through productivity.

Another cost increase that we are already seeing is higher diesel fuel prices which pressures margins and impacts earnings as a result of the surcharge lag. Our current spot price is running over $2.40 per gallon which compares to an average price of only $1.57 per gallon in the second quarter of last year.

Because of the inflationary pressures we faced, as well as need to increase shareholder returns pricing continues to maintain a focus within our organization. As we mentioned earlier, core pricing is expected to improve for the year as we achieve real pricing gains plus the benefit of legacy renewals and excellent service.

Assuming the economy continues to grow, we look forward to building of our first quarter momentum with continued operating ratio improvement, as well as solid cash generation from the business. Those gains support our balanced approach of deploying cash which involves investing in the business as warranted by returns, maintaining a strong balance sheet and rewarding our shareholder.

With that, let me turn it back to Jim.

Jim Young

Thanks, Rob. What a difference year mix. A year ago everyone was trying to find the bottom and we were focused on idling assets and reducing operating cost. Despite some lingering uncertainty, we are feeling better today about our opportunities for volume growth in a more stable economy.

The visibility to a future demand is still a little crowded however, so we need to remain flexible, be ready to act if the economy losses theme. We have significant volume leverage remaining in the systems so we look forward to additional growth.

[Good] operations are key to delivering upon our customer commitments, customers rely on the strong value proposition of UP’s service product allowing us to extend our supply chain reach and compete in new markets. We are also continuing to make the critical long term capital investments that support the company’s growth strategy.

Union Pacific is becoming more profitable producing stronger cash flows and generating higher finance returns which will enable us to reward shareholders for their investment in the great UP franchise.

With that, its time to open it up for your questions.

Question-and-Answer Session

Operator

Thank you, Mr. Young. We will now be conducting a question and answer session. In the interest of time and in order to allow as many as possible to ask their question please limit yourself to one question with a follow-up. (Operator Instructions). Thank you. Our first question is from the line of Matt Troy of Citigroup. Please ask your question.

Matt Troy - Citigroup

Dig a little bit deeper on the Intermodal side, there is obviously a lot of moving parts and pieces, but I wanted to be clear on the IMAX renegotiation, what kind of implications that would have wither for volumes revenues and ultimately operating profit. Do you have any estimates in terms of putting together all models just to give us a little bit of ability so we could minimize confusion on this end in 2010?

Jim Young

Matt we are not going to get into the details I think just suffice it to say it’s a positive for both of us in terms of our ability to put new products you have got some great service schedules our customers are going to have access to a great container fleet and it gives us direct access to mere the customers to help sell the proposition and you have to think about this long term in terms of the way that the new agreement has structured.

Matt Troy - Citigroup

Okay then I guess tying it back and then follow up to the core pricing story in the 3% - 3.5% range that you set for the quarter feeling that that was a low point can you help us in terms of just climbing out of that to a higher number for the year which you indicated would be your outlook, what are the core pricing gains X legacy X these intermodal deals I mean are we pacing higher than that and that’s really being dragged down by those two factors or how do we get from where we are today what are the parts and pieces that help us get to a level that’s higher than that 3% and 3.5% that you reported for the quarter just some detail there would be very helpful.

Jim Young

Well Matt again you have a lot of factors are [plain] to this. Obviously the mix the timing of legacy agreements, the length, you know as Jack had indicated our legacy deals are spread out over time, I also if you think about what Jack said we are already running about a point higher so far in April in terms of what we saw first quarter. You know the question really becomes one also what you assume on volume as volume and demand pick up should create even stronger pricing environment.

Jack you want to add to that?

Jack Koraleski

You know Matt its kind of like three things that I think you can kind of think about number one is we have said in the past that the Pacer contract basically increases overtime and this will be the last quarter that we have negative pricing in our Intermodal franchise, so that’s a good thing for us so, secondly some of our legacy contracts including the largest which was an automotive deal was a mid year or mid quarter first quarter transaction so there is greater strength moving forward from that the third thing is as we look to the pricing environment for the future we have tariff business in place right now that is still reflective of last years software economic terms those will change over time as we go through the year with continued strengthening in the economy. So we are feeling pretty good about what our price picture looks like going forward.

Matt Troy - Citigroup

I would imagine you are somewhere 80% or so negotiated for 2010, so you do have very fairly clear line of sight visibility.

Jack Koraleski

Yeah for the contract deals, but you know for the tariffs we have greater flexibility and already as we start to see truck capacity tighten and truck pricing going up those kinds of things, we are back at the table looking for opportunity.

Operator

Our next question is from the line of Tom Wadewitz with JPMorgan please go ahead with your question.

Tom Wadewitz – JPMorgan

Yeah good morning and just a great performance on the cost side very impressive. Let’s see the operating leverage is very good and it sounds like you have more room and the network to continue to handle volume growth with limited additional expense. I was wondering if you could give a sense of average train length in the car load network and average train length in the intermodal network and then a sense of kind of what the potential train length would be just giving a sense of some more sense of the operating leverage?

Jim Young

Duff, do you want to take that one?

Dennis Duffy

Tom the average train length that we have is for the entire system; all of our network is about 5500 that we grew about over 10% year-over-year, quarter-over-quarter. Our biggest growth obviously within the intermodal side, Jack showed you a 21% growth. We added about 20 boxes per train there and with a very minimal [fuselage] as you saw we only added a 1% [fuselage] there against the 13% volume. And when we look at our overall network, we think that we have another 10% to 15% on train length on a macro prospective, obviously that would differ by commodity groups somewhat, but we think over all that’s a pretty safe measure for us and would have to look at the corridors where the growth occurs, but we still see a good upside for our leverage opportunity on train length

Jim Young

Hey Tom. And I would be careful though on taking the first quarter and extrapolating it out. You know as Rob said this is more of an exponential relationship delinear if you start moving up towards that theoretical capacity we have in our system. We get a little more cost pressure, but we clearly have, we have got Dennis who have shown about 1300 - 1400 locomotives in storage. We have got 2600 employees per load. We are in some location starting to do some hiring, but again, I think first quarter is outstanding we hold our operating team to a high standard in terms of what they do the next three quarters but again you will get a little cost pressures as you move up that curve

Tom Wadewitz – JPMorgan

What in Intermodal specifically Dennis can you tell me how many containers per train you were on average in the first quarter?

Dennis Duffy

About a 160.

Tom Wadewitz – JPMorgan

160 Okay and that I guess in theory that number could go up to what like 260 or 270

Rob Knight

You are close right around 250 range, Tom.

Jim Young

Tom keep in mind, we can build very big train and have a negative impact on service and there is a serious consequence of that in our market. And Dennis’s task here to drive that productivity, but drive this service to new levels.

Dennis Duffy

And you have to be careful to mix in the two Tom, I mean between domestic and international. Obviously international is the tier double (inaudible). Domestic is a little more of a high breed, but with Jacks help and the marketing team, help we are transitioning most of that to double also.

Tom Wadewitz – JPMorgan

Okay, and then just a quick follow-up and I’ll pass it on. On the pricing do you think you can get to kind of 5% base rate increase when you get into second half, the third quarter, fourth quarter is that a reasonable way to think about it?

Jim Young

We are not getting into the guidance and where we are going. We do believe we have the upside a lot of variable. If you have a higher economy moving out here obviously we have more flexibility.

Operator

Our next question is from the line of Jon Langenfeld with Robert W Baird. Please go ahead with your question sir.

Jon Langenfeld - Robert W Baird

Good morning. Jim you have talked about in the past how overtime, longer period of time your goal is to offset half of the inflation through productivity. Just wondering how much of that opportunity have you eaten into here over the last 12 to 18 months and is that still a realistic goal as you think out over the next three to five years?

Jim Young

I think it is, Jon, our productivity again you have to be careful here. We got a lot of excess capacity right now as with idle assets that’s my definition of productivity that’s not great productivity when you look at asset utilization what’s stored here. But if you get back into where may be the normal run rate on volumes that we were looking at long term. I think assuming offsetting half of inflation is not unreasonable.

Jon Langenfeld - Robert W Baird

Okay. And then on the intermodal side, can you talk a little bit about how if at all, your strategy changes with regard to not only pricing but just how you go to market. I mean you significantly cleaned up the Legacy deals; you’ve really structured the market in a way that it advantages you in a major fashion. So how does that change how you market your product?

Jack Koraleski

It really allows us to deal now directly with the IMC community. We are not changing our strategy, we are not pulling away from the IMC’s and in fact what we want to do is offer an even better product offering for them and give them greater flexibility of choice whether they want to go ramp-to-ramp or whether they want to use our streamline door-to-door product which gives them a lot more flexibility working with their customers.

Jon Langenfeld - Robert W Baird

I was just going to ask does the end shipper see that, will they notice any different on the UP as they look out a year from now then where they were a year ago?

Jack Koraleski

They’ll see it in terms of more consistent reliable service.

Operator

Our next question is from the line of Chris Ceraso with Credit Suisse Group. Please go ahead with your question.

Chris Ceraso – Credit Suisse Group

You mentioned a few times, the leverage story which is very clear on a year-over-year basis. But if I look at the performance versus Q4, you had revenue up about 200 million on better car loads and some price but profit only up about 30 million. So that’s about a 15% contribution. Is it fair to look sequentially as we think about some of that leverage as we worked through the rest of the year and maybe you can help us with some of the puts and takes on a cost side that would have restrained that leverage as you walked from Q4 to Q1?

Jim Young

Chris, I’d be careful about making a comparison of fourth quarter. You get a lot of variables in there that are out here. I know we had I guess PI. We had some pretty favorable news on our personal (inaudible) accruals in that quarters that tend to do help that number. But I wouldn’t look at it as a negative. I mean Rob, do you want to?

Rob Knight

Chris, just don’t forget the one time CSXI payment is in the first quarter as well.

Chris Ceraso – Credit Suisse Group

Yeah, I excluded that. Okay. You sort, you mentioned export coal. Can you give us a little color around that how much of that are you doing? Where’s it going?

Dennis Duffy

Chris, we are not a big player in the export coal market. So for us, the idea, attractive situation of a increasing demand around the world, it really absorbs a lot of the eastern coal and then for us, it gives us the opportunity to move western coal east. We are about moving probably I would guess this year, maybe a million tons or so. It’s going to go the Long Beach and up to Robert’s bank, up in Vancouver so our two key port locations for that coal.

Mostly Colorado, Utah although we are getting some pushing and shoving around whether or not it makes sense to move some part of river basin coal to Asia, to China in particular. And we’re also starting now to see some greater interest in Mexico, moving coal out of the U.S. into Mexico. So, that’s kind of our plan in the international market.

Chris Ceraso – Credit Suisse Group

Just one housekeeping one. What do you expect the tax rate to be on a go forward basis?

Unidentified Company Speaker

It’s a more normalized thirty eight percentage.

Operator

Our next question is from the line of Bill Greene of Morgan Stanley. Please go ahead with your question.

Bill Greene - Morgan Stanley

Jim, if we think back, one of the questions we often get is if we look at some of the rail’s prior experiences in the last upturn in 2003, service levels obviously deteriorated. So what do you think are the right metrics for us to watch to kind of as a canary in the coal mine to look at things. We saw the train speed slow a little bit. But that maybe is there something to worry about so I know exactly how to think about the public metrics what you would watch if your were us to make sure that service levels are being maintained?

Jim Young

There is a good correlation of velocity. Its really is, we went backward a little bit first quarter but big part of that was weather and we’re back up to 27 miles an hour right now through April, so we are feeling pretty good but the metrics you get there were reported AR velocity, the inventory levels and cars and dwell time are pretty good indicators of the health of our network.

Bill Greene - Morgan Stanley

Okay and then if I can ask you a question about inventories. If we look at the merchandise customers you serve, have you seen much in the way of restocking from them already? Is that already past or are we still to see that come as the economy picks up? How do you feel their inventories are now?

Jim Young

You know Bill they’ve been really balanced. We have seen some inventory replenishment but I think the general mood and attitude right now with the bulk of our merchandise customers is they are going to rely more on kind of a just-in-time inventory process, they are being cautious about placing orders and overstocking so there’s a good management flow around watching the balance between inventory and sales. If you look at the inventory sales ratios right now, they are looking really good and even with the up tick in volume, we don’t see a lot of inventory build that I would be concerned about in terms of overhang. I think it’s pretty much been demand driven which is really healthy.

Bill Greene - Morgan Stanley

And then just one on buybacks, what are the metrics you watch for when you get comfortable adding those back. Thank you.

Jim Young

Well as I committed every quarter in here our job’s here’s to create a financial performance and the cash flow that put us in a good position and you know we said as we feel better about the business this year, we’re going to take a hard look at what we do next in terms of returning cash for shareholders.

Operator

Our next question is coming from the line of Scott Flower with Macquarie (inaudible) Please go ahead with your question.

Unidentified Analyst

Jim I wonder if you can give us some flavor on what’s going on in Washington. Obviously you all are very well positioned and understand the dynamics. Is that just something that there are just so many other priorities that what’s going on with the bills on the rail side are just not moving very quickly and there are just too much other focus or how do you see things playing out there?

Jim Young

Well Scott we are continuing to be engaged with the members in terms of the health of our industry and the value our industry creates. I would view right now that its not in the top of the priority list when you look at all the other challenges that DC is working with but you can never underestimate the potential here and as we’ve said consistently, we are engaged and helping. Every member I talk to you go back, they value rail. It’s interesting when you sit across from a member who thinks about the realm of value that brings in terms of jobs the value it brings in terms of energy efficiency. So nobody wants to get this wrong here. And we’ll see what happens but right now I don’t see that the rail piece is at the top of the list in terms of priority.

Unidentified Analyst

Is this something that gets pushed out past the election?

Jim Young

There’s clearly a possibility there but we’re going to always be engaged.

Unidentified Analyst

Okay and then the other quick one for Dennis is, how do we understand how you had the drop in your local stores with the volume growth you had, that’s the other thing impressive statistics.

Dennis Duffy

Well this portion of the growth Scott was in the intermodal and auto and we continue to the unified plan to make those efficiencies and look for combinations of potential reductions and so we’ve squeezed down the overtime, squeezed down starts and we are able to even take out days of the week and I think I reported to you before we idealed at almost up to 30 of our yards of our satellite remote yards. If that’s a give and take, we’ll add at one or two every once in a while depending on where we see the growth but the overall productivity levels are up, as I said across the board, particularly in our manifest yards.

Jim Young

If you think about our industrial products business which is primarily manifest, we’re still substantial. Its first time we’ve had growth in several years, we’re still substantially below the kind of peak levels we saw back in ‘07. Let me give you an example, lumber loadings in the peak second quarter 2005 we loaded in that peak quarter about 63,000 loads of lumber. We hit a bottom here last year about 18. We loaded first quarter about 22,000 so that just gives you a perspective of how low business got in some of these areas and still have long ways to go.

Operator

Our next question is from the line of Jason Seidl with Dahlman Rose. Please go ahead with your question.

Jason Seidl - Dahlman Rose

Quick question, just kind of looking at how you trend throughout the year normally you know with to see us expanding being one time you really sort of sub 74 operating ratios is that about right? The way I look at this thing and…

Jim Young

It was about 1.1 point. You do the math.

Jason Seidl - Dahlman Rose

Yeah just some sort of it was 739s and you know with the pricing improving and you know volumes still there and you are still seeing some productivity, in fact your current speed should pick up as you know we are not going to see the same type of weather impact for 2Q. I am just wondering how quickly do you think UMP can sort of get back to the sort of 70 OR type of environment given all the things that we mentioned and given your productivity gains. I don’t know the time horizon but just it doesn’t seem like its added a question when I look at the model.

Jim Young

Well the only long term guidance we have still hanging out there is the view that will be net low 70 OR by 2012 and we’re feeling pretty good about it.

Jason Seidl - Dahlman Rose

Yeah and it seems like you are on your way. May be this is a question for Rob. Rob I think you said in the other income you had 16 million from early debt retirement. Did I hear that correctly?

Rob Knight

That’s correct.

Jason Seidl - Dahlman Rose

What should we expect going forward still sort of the sort of 15 to 25 million range for the rest of the year on a more normalized basis.

Rob Knight

Yeah that’s probably not a bad number Jason. I mean we had bad real estate sales were a little lower in the quarter as well so that can fluctuate that number but that your thinking is not off track.

Operator

Thank you. Our next question is from the line of Walter Spracklin with RBC Capital Markets. Please go ahead with your question.

Walter Spracklin - RBC Capital Markets

Just going but to the train line thing, I noticed that during the quarter you touched on the 3.5 mile on train, pretty long train there. Just wondering what you might have gathered from that and any new information with that test. And sort of as a follow on to that there was some public backlash against the length of that train, I think they were misunderstanding the whole reason you are doing it but what are your impediments. You mentioned service is a limiting factor, is there any other limiting factors like things like this kind of public opinion thing.

Dennis Duffy

Well Walter it’s actually a proof of concept. We had some new technology that we were trying out with our locomotives and our DPUs. We proved we could do it and that was a one time deal. We are not going to repeat that kind of an issue with those long trains but remember, the leverage in train length is on the average train length. It’s not on the maximum train length and we did prove we could do it, we did learn some things. We think that we have, as I said earlier, adequate opportunity for upside leverage here on our train lengths. We are dealing it with inside of our capital budget here, some of the impetus that we may see an exciting length and we have a few exciting extensions I’ll run through track capacities, we’re addressing those as we go along.

So as I said, we are around 5,500. We have plenty of upside left there across the board and we continue to press the technology and we’ll appear to be able to accommodate those trains.

Walter Spracklin - RBC Capital Markets

Perfect, just a follow up question here now on the attrition side you mentioned attrition, to what extent can you remind us here your yearly rate of attrition and to what extent is that helping you in sort of realigning your work force and bringing people back to fill jobs due to attrition as opposed to higher volumes.

Jim Young

Well it’s a key component and if you will recall back about three years ago we were running about 7% to 8% attrition, that’s fallen off here and last year so which wouldn’t surprise you where people are deferring retirements or defer may be looking for jobs elsewhere but we expect this year to lose about 3,000 employees, that’s down from kind of the peak of 5,000 plus and it will continue.

I mean you’ve heard us talk before, the baby boomers will move into the chain and are retiring so it’s given us a good opportunity to manage our employment levels to attrition. If you look at our numbers, we hit a peak on our employment of around 51,000 to 52,000 employees a couple of years back. We finished this quarter at around 42,000 or so, a big piece of that was attrition in terms of just simple not filling jobs as they left.

Operator

Our next question is from the line of Justin Yagerman with Deutsche Bank. Please go ahead with your question.

Justin Yagerman - Deutsche Bank

All right, I guess a question going back to the pricing side of things, I wanted to get a sense you said that you had a contract on the auto side that reprised mid-quarter this year and mid quarter this quarter and that was part of the point bump that we are seeing in Q2 right now. Are there any other timing guidance that you can give us throughout the year in terms of when any of the other legacy contracts or repricing that we could expect to model in perhaps some improvement?

Jack Koraleski

Sure Justin we have the one in the first quarter. We have the fact that Pacer ramps up over the year so that will change over time. The (inaudible) side contract basically takes effect in the second quarter and then we do have a couple of mid year legacy deals in the July kind of mid year timeframe, not the biggest of deals but a couple there that will come on stream.

Justin Yagerman - Deutsche Bank

Okay that’s helpful and I guess just vis-à-vis that and may be giving a little context around it, you talked about better fuel surcharge recovery and I am assuming that comes with some of this intermodal change. Can you speak to where you’ve been, where you are now and where you expect to be on a full run rate basis in terms of offsetting incremental fuel costs as we kind of move through 2010 and exit into 2011?

Rob Knight

We continue to make progress and you are right as we continue to click off legacy contracts and as Jack talked about the intermodal that improved our position, we’ve done a great job of moving forward on the recovery and minimizing the negative impact that comes with rising fuel prices. We still of course have the risk of the challenge from quarter-to-quarter should there be swings in fuel prices with the lag effect but we’ve made great progress on a recovery. We are going to continue to make progress as we move forward.

The other thing just talking about fuel, when you look at the impact of fuel year-over-year it costs us in the first quarter about $0.10 EPS and that’s primarily a result of the fact that we got a $0.20 plus as a result of favorable surcharge lag last year. So you kind of get those swings from quarter-to-quarter depending on what’s happening at the timing of the recovery but the bottom line is we continue to make progress, we have made great progress in minimizing the negative impact as a result of the contract.

Justin Yagerman - Deutsche Bank

Is there a number that we should think of in terms of incremental fuel costs recovery that you guys are able to achieve now versus prior and may be where you think you are heading?

Rob Knight

I can’t give a number Justin and there’s 75ish kind of fuel surcharge programs in our market. So trying to tie to a single number is not particularly useful at this stage, I think the bottom line here is we’ve really kind of removed that as being a major negative rising fuel price environment.

Just on an annual basis as Rob said, we pretty much neutralized fuel either way, you just have to be a little careful on a quarter to quarter basis particularly when you get a spike either way that you can have bigger impact on your earnings in that quarter but because of timing, on an annual basis we’ve pretty much limited it the majority of the fuel variability.

Justin Yagerman - Deutsche Bank

Sure and I am looking through the year on the cost side. Workforce productivity is impressive and getting a sense that you are starting to get to those friction points on productivity where you’ve got to make some decisions. When you guys are sitting there looking at that and trying to figure out how to bring on clues and what have you. What are the key metrics and what should we be looking at? When we look at our labor costs should it be more tighter volume, more tighter revenue, more tighter what we think OR should be and I guess the balance of all three to some extent but may be if you could give us a little more color on how you make those decisions.

Jim Young

Justin its tighter volume I mean it really is. I mean we do look at kind of productivity offsets but you start adding more volume it will eventually add more train starts which means we’ll eventually have more train crews that we are going to again more volume will drive more maintenance. So, I want to get back to where, we’ve got a strong hiring program going on. That means we have got good growth in our business. We see good long term opportunity but at the end of the day volumes is the prime driver.

Justin Yagerman - Deutsche Bank

Okay and last one, I’ll turn over to someone else. Just wanted to confirm CapEx guidance still the same with $2.5 billion no change on PTC thoughts?

Jim Young

Right now we are at the $2.5 billion range, PTC still about $200 million in that number.

Operator

Our next question is from the line of Ken Hoexter with Bank of America/Merrill Lynch. Please go ahead and ask your question.

Ken Hoexter - Bank of America/Merrill Lynch

Great, great job on the quarter but just on the pricing side, you measured a little differently than the rest of the rails. Everybody else kind of throws in same store sales basis, so, you do it if I recall right over the entire base which may be dilutes that number a bit. Do you have an idea what it would be if you just thought about it on a same store sale basis?

Rob Knight

Ken it’s not a number that we talked about but it will be logically a little higher of course than the way we report and just to elaborate on the points you’re making you’re exactly right. The way we calculate price is we take it across our entire book of business. So it’s a yield if you will that takes into consideration every dollar of our revenue even that which we haven’t been able to touch for the contracts. So it is a conservative way of looking at price that’s how we have looked at it but so if you dissect it, just the same store sales base which we don’t, we won’t be logically be a little higher than that.

Jim Young

I think one thing keep in mind in price here, we have to get price up. At the end of the day, with the folks of productivity, you look at the amount of capital we’re putting into our business. We are working hard this year in terms of our performance and you are going to work hard in terms of you look at return on capital. We’re working hard to get this thing above a double digit number. So, you should hear from many of us that we are satisfied with where price is because it’s got to up. You think about replacement cost cash flow in the investment that this company is facing long term, it has to go up in terms where we are at or you can’t just by the kinds of investments we’re putting in this business long term.

Ken Hoexter - Bank of America/Merrill Lynch

Actually I am going to back to Rob on a follow-up as well but on the productivity, you talked about not bringing it back to one to one at this point but looking at the draw down of the furloughs in your locomotives and cars, when do you need to start pressing the labor ahead of time? When do cost start, I know you said it comes in stair step functions during the remarks before, but when do you think it needs to start leading the volume growth and how long does it take, remind us of kind of training the employees to be able to be proficient again?

Rob Knight

Well, keep in mind Ken that we have got a program, we call it alternative work, unique in the industry where we didn’t 100% furlough on employees. We actually had several thousand at the peak where we are paying 100% of their benefits and they were getting about eight or nine days of work. So, they were current. We have a very disciplined process that looks at each territory who understand lead times, we keep in touch with our fellow employees. We are not going to jeopardize safety. If you have someone that’s been off for a year, you don’t call him to work and they’re operating a train that current day. It’s underway right now. We have quite a few people that are out getting refreshed in training. Dennis, you want to add anything to that?

Dennis Duffy

Just to add on a little bit if I can, we try and keep six months of future attrition in that kind of a status where we have them already training; we’ve done this now for a couple years since the downturn has been with us in that. And then, on a locomotive side, we’re rotating the stock so that we know that these locomotives are good and ready to go when we put the challenge through the locomotive and mechanical team, we know what we’re going to have, and so, we keep about three hundred locomotives always in rotation that come in out of storage and we have a reliability profile built for those locomotives and we can anticipate what’s going to happen when we do put them in service. So, we’re ready.

Operator

Our next question is from the line of Tom Marsico of Marisco Capital. Please go ahead with your question.

Tom Marsico - Marsico Capital

I was just wondering if you could comment a little bit, what you seeing from the economy and talking to your customers throughout the quarter. I’m noticing a little different intonation and I’m wondering if it’s the case that you’re feeling a little more confident about what you’re seeing from your customers and the viability of the recovery in the economy, given your comments around just-in-time inventories, stocking versus jus re-stocking. Am I reading that correctly?

Jim Young

That’s right Tom. In fact, we just, last couple of months between Jack and I, I think we probably talked a 150-200 customers. I would say they’re cautious. They are little more optimistic then they were fourth quarter and third quarter. There are clearly some categories I was with one of our really large chemical customers who said.

This is inventory, replenishment and by the time they get to mid-year they are going to see it pull off. I was then with other customers that they are struggling to keep up with demands. There was one common thing that I did. What I was always interested into and ultimately I think this is the measure any business, (inaudible) hiring. I mean we have enough confidence; there is legs to this thing that you are willing to go out and actively higher. Most of my customers, they have been utilizing it by this much over time as they could. But they are right on the edge.

Tommy answer is, not many of us really now. We are surprised, if you look at volumes through April, this could be benchmark here. Our volume in April is holding in there. We are up I think 18% or 19% through the first three weeks in terms of our volume. So I haven’t seen it fall off at this point. But again, I think the key whether you’ll start seeing hiring numbers get a little stronger.

Operator

Thank you our next question is from is from Edward Wolfe of Wolfe (inaudible). Please go ahead with your question sir.

Unidentified Analyst

Can you just give me a sense on the mix, the break down of the mix and the fuel you gave the pricing that makes up to 2.8% yield.

Rob Knight

In rough numbers, average revenue as far as you see is a free, deal was a roughly three and mix was roughly a negative three. And the reason mix was so strongly negative, to the point we had such strong growth in our intermodal and automotive business groups.

Unidentified Analyst

Okay, when I think about what Jack said about pricing tracking, one point higher in April than first quarter. Jack did you mean 1 percentage point above the 3% price excluding our [ARC] or the 3.5% including ARC.

Jim Young

I am saying right at moment, its about a percent higher and that is again the core price number. The core price number, the three is looking like four so far in April.

Unidentified Speaker

Okay so excluding the ARC.

Unidentified Analyst

If you think about it I know there has been a lot of people trying to get that pricing, but I guess the thought is that if you look at pricing excluding ARC went from 3.5 in fourth quarter to 3 in first quarter despite the 5% or 6% of legacy contracts replacing early in the quarter. And you have actually have better absolute volume in first quarter than fourth quarter. So it’s the sense that’s lagging that pricing that was going down six months ago, nine months ago. And now we are starting to turn and inflect and that’s why it starts to go up in second quarter. Or is there something else I am missing there.

Jim Young

Again its, mostly attributable to the domestic intermodal legacy overhangs that are going to shift, and we are going to be in a better position here going forward in the second quarter and beyond. So that’s really kind of the key driver of that. Its pretty much a timing issue.

Unidentified Analyst

So I guess, the intermodal as a driver going forward, but the first quarter being worse than fourth, is that lagging stuff that just takes a little while to play through?

Jim Young

Yes sir.

Unidentified Analyst

And then on the share re-purchase timing and I guess back to your answer to the question before, do you not have confident yet in the economy that the recovery is sound enough here to buy back stock at this moment in time?

Unidentified Company Speaker

Ed we are feeling better, I think everyone right now is surprised at the strength in first quarter and what we are seeing so far in April and if we see these things sustained here as we are going forward, we commit into our shareholders we are going to look at how we return some cash.

Operator

Our next question is from Scott Malat with Goldman Sachs. Please go ahead with your question.

Scott Malat - Goldman Sachs

We have just really seen some shipping rates increase out of China. You talked a bit about the coal but can you talk about what you are seeing from Asian demand and outlook from some of the other categories maybe green that was paper good or anything like that?

Jim Young

We are seeing some good strength in our international, intermodal, finally its up 12-13% so and it looks fairly sustainable and it looks like we’ll actually have a peak season this year, so that’s a good thing for us. The grain business right now, the export markets in the world supply is going to shift here and that’s going to hurt US exports but domestic, it looks good. It’s a little early to say in terms of getting the crops planted and how the harvest is going to look in terms of potential, but at least the initial indications are you will see larger corn and bean crops which should be good for us and certainly the ethanol business and DDGs associated with it are strong.

Autos as I said, continued strength is what everybody is looking for. Energy, we are feeling more bullish about. We’ll just have to see how that plays out, what we need though is a nice strong hot summer that will be useful. Industrial products is turning for us in a good way and that was kind of my key benchmark. The three things I was looking for was rock, cement and lumber and my theory is that an economic recovery isn’t sustainable unless you have those three planned and we’ve actually seen a nice up tick in lumber and now the rock business is starting to show some good so we are just waiting for cement.

And then we have already talked about intemodal. I think not only do we have the great upside on the domestic piece because the service is excellent and we’re seeing highway conversions at a much higher rate than what we had thought we would and that the new max program had some great (inaudible) competitive schedules going to the north east. That’s gaining share and of the highway and the international solid and I think you need to look at also what’s happening with truck capacity as you know it has been tightening, pricing has been firming up which again, if this economy has some lakes that should give us additional opportunity rest of the year.

Scott Malat - Goldman Sachs

Just a quick data plan and just how much your business is now still on legacy contracts?

Jim Young

It 12% is I think where we had left for the rest of the year but you need to keep in mind that things like Pacer, some of those are ramping up over time. So 12% is what’s moving under a legacy deal that has not been repriced since 2004 and we’re making progress on all the others.

Operator

Our next question is from the line of Chris Wetherbee of FBR Capital Markets.

Chris Wetherbee - FBR Capital Markets

Jack a quick field question for you, just from an our cap perspective, can you give us a sense of what that might look like in the second quarter from an escalation perspective and how that kind of factors into the 4% growth you are talking about?

Rob Knight

As you have seen the published projected our cap of fuel component is expected to go up in the second quarter versus last year second quarter because of the change in fuel price but its all part of our expectation and our confidence that we are going to improve our pricing going forward but keep in mind that our contracts that renew that have an archive fuel component in the index, its not linear. I mean it can be lumpy and it’s not all of them reset for example on the second quarter. It builds into our overall confidence that things will improve from here.

Chris Wetherbee - FBR Capital Markets

I guess just one quick follow-up question, sticking with you Rob, I guess on the health and welfare kind of cost increases that we’re seeing on a year-over-year basis. Can you give us a sense of what that trend looks like as we go forward to the next couple of quarters may be on an absolute dollar perspective if you can get that granular that would be great.

Rob Knight

Yes, you may recall in our last quarter earnings we indicated that, health and welfare cost would be higher and as a result we projected and did give guidance that we thought the inflation on our overall labor line would be closer to 5%ish. And in terms of absolute dollar amounts, that’s probably roughly $25 million quarter kind of number.

Operator

Our next question is from the line of John Larkin with Stifel Nicolaus. Please go ahead with your question.

John Larkin - Stifel Nicolaus

Good morning gentlemen and thanks for taking my call. On the healthcare cost increase front may be Rob can answer this one, have you factored in any cost associated with the healthcare reform package the past time was here recently?

Rob Knight

Yes, but its not going to be a major challenge to us and it’s not a hit to us in the first quarter as you’ve noticed in our earnings. So, yes and I guess I have to say because who knows what it all brings in terms of the actual details of the bill, but my number does take into consideration what we know about the healthcare bill yet.

Jim Young

John, we have to think about it two ways. The direct impact on our programs right now at least in the short term is not a big hit but what does it mean long term to our customers or suppliers that we have to work through. So, we are going to keep our eye on it.

John Larkin - Stifel Nicolaus

Thank you and then I think somebody mentioned the fact that you are continuing to work to convert what I’ll call single stack intermodal service to double stack. Where do you think you are in that conversion and how much is left and how much just in a very general terms more profitable is a double stack operation compared to a more traditional (inaudible) operation?

Dennis Duffy

I’ll be glad to answer Jack’s profitability. As far as the upside John, what we have, a good portion of it depends on the lanes obviously but in some lanes we’re at 85% double stack, other lanes were as high as above 95% to a 100%. So there is some transition going on in some of these trailers to containers, Jack and John and the marketing team are working through. So I’d say we have a few percentage points to go on an intermodal network here before we get to where we want to be.

Jim Young

But to think about the operating efficiency, I mean you are doubling the volume technically on a train. If you have single stack versus double stack it’s a significant improvement in operating efficiency and then as a consequence to that should be on a margin.

Rob Knight

If you look at our data you will see that trailer business is a very small portion of our total intermodal. I forgot what the actual number we’re down to now but I wouldn’t be surprised to see it in the 5%, 6%, 7% kind of a range. And there is a price differential. Its not exactly that just because we double stack with the pricing on the trailer business is significantly higher than the pricing on the double stack business and that reflects market and the demand that’s out there truck competition and everything else that we have to consider.

John Larkin - Stifel Nicolaus

On a similar note couple of years ago I used to talk a fair amount about converting a lot of the, what I would manifest car load business in to unit trains wherever possible. Is that still a lever available to you or are you more or less converted everything that can be converted at this point.

Jim Young

It’s really kind of a growth cycle for us because you start off with an opportunity, it’s a small group of business over time, that customer grows, service is good and eventually we go to multi-car blocks and then eventually in places like pipe and in track sand and now windmills and all of those kinds of things we are able to convert than into unit train business that then creates more opportunity for a manifest that opens up available capacity in the manifest network and we go out and get additional business to fill that. I think we still have some opportunity

John Larkin - Stifel Nicolaus

How much of the volume currently moves in what I would call manifest trains versus unit trains?

Jim Young

Well manifest is about a third of our overall business.

Operator

Our last question is coming from the line of Jeff Kauffman with Sterne Agee. Please go ahead with your question.

Jeff Kauffman - Sterne Agee

Dennis we talked about system capacity, you talked about the average number of cars per day you think you can get on the system, maybe that’s 15-20% higher than now but I know velocity helps that capacity, your management helps that capacity. So if I look at it three buckets, how much capacity the track can handle before we need to change things. How much capacity volume you can grow before you really need to start making changes to the cars, locomotives and how much capacity you can grow before you really need to start adding the people and you mentioned you were doing some hiring now? Can you give me rough idea of where those start to kick in so I can get an idea how the incremental margins retard a little bit as growth gets to X lets say?

Dennis Duffy

Jeff if you take a look at that upside leverage chart that I showed here, if you think about the track infrastructure, that’s really the throughput category, that’s the fixed resources and when I say we are sized for 190,000 to 200,000, that’s the fixed plan. That’s the main lines in the terminal and then when you look at the rest of it you know on the cars and locomotives that would be more on the train size discussion that we had. We’ve given out the number 10 to 15% beyond where we are today and then the adding people as Jim talked about, that’s incremental. As the volume comes back and we look at the train starts we are anticipating them.

But remember we’re training ahead. So we’ve got those costs already into our cost structure. We do see that we may have to do more engineer training if the volume continues and we may have to do some more relocation as I indicated in there. So the adding people part is incremental with the growth number and that’s the best surrogate we could look at is that seven day number to try and graduate what an estimate might be in terms of people coming back.

Operator

I would now like to turn the floor back over to Mr. Jim Young for closing comments

Jim Young

Well again, thank you for joining us this morning. I hope you see we are keeping our commitments to our shareholders in terms of our performance and we are looking forward to talking to you again in July. So again thanks for joining us.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Union Pacific Corp. Q1 2010 Earnings Call Transcript
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