Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Jim Young - Chairman, President & CEO

Jack Koraleski - EVP, Marketing and Sales

Lance Fritz - EVP, Operations

Rob Knight - EVP & CFO

Analysts

John Larkin - Stifel Nicolaus

Scott Group - Wolfe Trahan & Company

Walter Spracklin - RBC Capital Markets

Tom Wadewitz - JPMorgan Chase

Brandon Oglenski - Barclays Capital

Jon Langenfeld - Robert W. Baird

Jon Langenfeld - Robert W. Baird

Allison Landry - Credit Suisse

Bill Greene - Morgan Stanley

Ken Hoexter - Bank of America

Cherilyn Radbourne - TD Newcrest

Anthony Gallo - Wells Fargo

Rob Salmon - Deutsche Bank

George Pickral - Stephens Incorporated

Union Pacific Corp. (UNP) Q3 2010 Earnings Call October 21, 2010 8:45 AM ET

Operator

Greetings and welcome to the Union Pacific's third quarter 2010 earnings. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded 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 now begin.

Jim Young

Good morning everyone, welcome to Union Pacific's third quarter earnings conference call. With me today are Jack Koraleski, Executive Vice President, Marketing and Sales; Rob Knight, our CFO; and joining us for the first time is Lance Fritz our newly appointed Executive Vice President, Operations. As you all know, Dennis Duffy our Head of Operations since 1998 retired this month. Dennis was a great asset to the UP team helping transform our rail operations and we all wish him the best.

Now for earnings, in the third quarter we are reporting record results starting with our earnings of $1.56 per share. That's a 54% increase versus the third quarter of 2009 and our most profitable quarter ever. Third quarter operating income was a record $1.4 billion, a 46% increase. Similarly to last quarter, we achieved volume growth across each of our six business teams.

Total third quarter car loadings were up about 14% to more than $2.3 million, that's our highest level in two years but still 9% below our peak in 2007. As business levels on Union Pacific continue to grow, we're providing excellent service to our customers as recognized by a new best in quarterly customer satisfaction.

We're utilizing proceessees, technology and our commitment to excellence to safely and efficiently deliver the service product customers expect from Union Pacific. We combined strong volume growth, pricing gains and great operating efficiency to produce a record operating ratio of 68.2%. This is 5.6 points better than last year's record performance and our second consecutive quarter under 70. It's very rewarding to report another record performance on behalf of Union Pacific who provide great service to our customers everyday.

As business levels increased on our railroad, we are leveraging our capital investments and delivering on the customer commitments and potential of the UP franchise. So with that let me turn over to Jack to walk through the performance of our business gains. Jack?

Jack Koraleski

Thanks James and good morning. Well with excellent service in an improved economy our third quarter volume increased 14% as all six businesses again posted gains. Our core price came in at about 5.5% with improvement in each of the six groups. Those price gains combined with a boost from increased fuel surcharge revenue and offset by some negative mix produced a 6% increase in average revenue for car overall.

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

The strength of our value proposition was reflected in our customer satisfaction scores where we set a new best ever quarterly mark of 90. Satisfaction actually improved as we moved through the quarter even as volume grew heading into peak season. In September, we scored a 91 setting our new best ever month.

So with that let me walk you through the performance in each of our six businesses. Ag products revenue grew 16% of 7% volume growth combined with an 8% increase in average revenue per cost.

Strong worldwide demand for US wheat, corn and soybeans drove over 47% increase in wholegrain exports. That strong pull of the export led to a slight reduction in our domestic shipments. Ethanol continues to be the most significant driver of growth in our green product segment with volume up 1500 cars or about 9%.

Growth in DDGs also continued with volume up 4% including meal shipments were up 23%. Last but not least strong US demand for Mexican beer led to a 22% increase in import beer volumes.

Our automotive revenue grew 36%, as an 18% increase in volume combined with a 16% improvement in average revenue per car which reflects some of the contracts that we have re-priced over the recent past.

Volume gains were the result of a 32% increase in finished vehicle shipments as production levels in 2010 continue to closely match vehicle sale. With around 50% of our finished autos and parts business moving to and from Mexico, the flooding in Mexico and South Texas and the aftermath of Hurricane Alex resulted in supply chain disruptions that led to flat volume in our vehicle parts business.

Our chemicals volume grew 9% which combined with a 5% improvement in average revenue per car produced a 14% increase in revenue. Fertilizer volume was up 26% largely on the strength of export potash. Continued strong demand for finished lubricant and fuels produced an 18% increase in petroleum shipment. The start-up of the unit train service as well as incremental manifest business to unloading terminal that St. James, Louisiana drove an 80% increase in volume in the emerging crude oil segment of this market.

Plastics car loading were up 7% with growth and domestic shipments and movements to storage and transit more than offsetting a decline in export volumes and industrial chemical shipments grew 5% boosted by increased industrial production and a return to more normal inventory levels.

Turning to coal, our energy revenue was up 11% as volume grew 1% and average revenue per car increased 10. The fourth hardest summer on record and the increased demand for electricity that comes with a stronger economy drove 4% growth in southern part of river basin tonnage.

By the end of August the SPRB stockpiles were actually slightly below normal levels having declined to an estimated 53 days of burn, down from 75 days at the same time last year. Unfortunately, demand for Colorado and Utah coal continued to be weak, contributing to a 12% decline in volume.

Coal stock piles remain above normal in this market, which faces strong competition not only from Eastern coal sources but also from natural gas conversions in the East. Additionally production downtime associated with relocating mining equipment to other reserves reduced coal supply and will most likely continue into 2011. Industrial products revenues grew 25% of the 20% increase in volume combined with a 4% improvement in average revenue per car.

With a stronger auto industry and increased drilling activity driving demand for steel, our steel and scrapped car earnings grew 44%. Non-metallic mineral shipments were up 38% and that increased drilling activity also translates into demand for (frac) sands, ferrites and bentonite. Hazardous waste shipments were up 101%, again driven by year-over-year growth of uranium tailings for the Department of Energy. Despite solid profitability, this high volume low revenue per car short haul movement has a significant negative mix effect on overall industrial products where average revenue per car would actually have been 8% if we excluded the impact of the uranium tailings move.

Last but not least, while there's been little improvement in construction related markets our rock shipments were up 20%, supported by drilling related construction. Our lumber and cement shipments were actually down year-over-year. A 24% increase in intermodal volume combined with an 8% improvement in average revenue per unit to drive intermodal revenues up 34%. International intermodal volume grew 30% as improved consumer demand and some inventory replenishment led to a strong peak season.

We also benefited from share gains by our largest ocean carrier. Excellent service, that's competitive with single driver truck in major lanes, continues to attract highway conversions, driving a 16% growth in our domestic intermodal segment. Our streamlined subsidiaries, door-to-door product grew 70% with about half of that growth coming off the highway. For our international segment, average revenue per unit was up 4% with price gains and fuel recovery partially offset by a combination of negative mix as more revenue moved back to the west coast to address the shortage of boxes in Asia and our last remaining international intermodal legacy contract continued to grow.

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

As we look to the rest of the year, the diversity of our business is again emerging as the strength. We should continue to see volume growth even if some markets are struggling to show some signs of recovery. With no indication of any dramatic change up or down in the economy our run rate should hold until we see the normal softening as peak season winds down and the end of year approaches.

Tight truck supply will create opportunities not only in intermodal but our carload business as well and a strong value proposition built on great service will put us in a good position to capitalize on opportunities across all six businesses. Coal price improvements will combine with volume gains to drive our revenue growth.

Let me just give a quick overview of some of the specific growth drivers that we expect to see in the fourth quarter. In our industrial products business they look to have the most upside with the best opportunities in markets that are benefiting from improved auto production, increased drilling activity and hazardous waste disposal.

International and domestic intermodal segments will continue to drive growth with some indications that the international peak maybe slightly longer than we had originally thought. Fall demand for fertilizers is expected to be stronger than last year and petroleum should also post gains with growth in crude oil shipments to (St. James) and increased residual fuel oil moves. It also looks like industrial chemicals and soda ash are going to hold their current run rate so that will close the year stronger than a year ago.

Increased electrical demand and the expectation of inventory replenishment following a hot summer are expected to keep our coals trains moving and while feed grain exports will likely not be able to match last year's near record levels; wheat exports should provide a nice boost to our Ag products businesses we closed the year and moved into next.

Finally, we expect our automotive run rate to hold steady as sales are forecast to stay in the mid $11 million range through the end of the year with production slightly ahead of the fourth quarter of last year. So, that's how we see the quarter shaping up and with that, I'll turn it over to Lance for his report on operation planned.

Lance Fritz

Thank you Jack and good morning. Let me start today with safety which is where our operating team starts everyday. Through the month of September, the employee reportable injury rate is at 1.36, a 6% improvement versus last year. With safety, we focus on continuous improvement towards the ultimate goal of zero incidents. We also emphasis severity to lessen the impact both to the employee and the company.

In addition of the human and financial benefits running a safe operation enhances service and productivity. Training is especially important today in the onboarding process as we bring employees back from furlough who haven't worked for us for a year or more. And as our hiring efforts increase, our ability to put new employees in the train service with a safety mindset is crucial.

Turning now to service. Our service score card for the quarter is illustrated on slide 15. As carloads grew almost 5% from July to September, our service delivery index remained near record levels and velocity increased through the quarter by applying the principals of the unified plan and utilizing available resources, we absorbed the increased workload on the network while maintaining excellent customer service.

I'll talk more about productivity in a moment but we continue to see the benefits that volumes brings to our network. Our high service levels were challenged by Hurricane Alex and its impact on South Texas. Traffic was embargoed over the Laredo and Brownsville gateways for most of the month of July which normally handles nearly 50% of our north south Mexico traffic.

In addition, Eagle Pass our second busiest crossing point was closed for a week before we were able to start using it as a relief valve for our customers. We demonstrated network resiliency as service improved from August to September once we put the Hurricane behind us.

Dialing it down a level, the local operating teams are doing an outstanding job on the basic blocking and tackling of local service. They established operating plans that meet customer commitments, communicate with customers and then execute those plans. One of those blocking and tackling elements is captured by industry spot and pull which came in more than five percentage points better than last year even though we tightened the measure.

Consistent with Jack's discussion on record customer satisfaction, local customer satisfaction is also at an all time best. Different from the broader customer satisfaction measure, this survey solicits its feedback from customers we interact with daily at the shipping and receiving docks where the accuracy and reliability of our industry cruise is critical.

Quality services also cost efficient. In the third quarter we leveraged volume through our transportation plant, increasing car loadings faster than cruise starts as volumes grew 14% in the quarter versus only an 8% increase in total crew starts.

Let me give you a few example. First, gross ton miles per employee increased 9% in the quarter as we utilized more employee resources to handle the increased volume, but not on a one-for-one basis. In fact this our strongest quarter of employee productivity in almost seven years. Train length increased for almost every train type with intermodal and auto up 8% and 6% respectively versus last year and with intermodal train length we hit both a quarterly record of 170 units and a monthly record of a 171. Increasing train length enables us to control train inventory levels which is critical to velocity and service.

Freight car utilization also remains strong in a quarter despite a nearly 3% increase in the length of haul. Prudent use of our working resources enables us to leverage volume. This slide gives us a quick status update.

In terms of employees, we still have 1100 on furlough. While recall rates have averaged better than 80% this year, the current furlough pool has been out of work since late 2008. So we expect only about half of these to return to service. Because of this, we are ramping up our hiring efforts system wide for 2011.

Our locomotive resources are still in good supply although the average age of the remaining surplus fleet is about 26 years and we have fully deployed our DPU locomotives. And our freight car storage numbers currently around 30,000 a biggest change since the second quarter is demand for covered hoppers to support export grain demand. Although it's normal for us to have stored cars as a result of seasonality, we would expect the more normal storage number to be around 10,000 to 20,000.

As we approach the end of 2010, I would like to update you on the progress of our capital program. We are still targeting approximately $2.6 billion spend this year but the allocation of that spend has changed the level. Replacement capital accounts for about 70% of the total with the bulk of that devoted to infrastructure.

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

We successfully completed work on the new Joliet Intermodal Terminal which opens for business in August. We are purchasing 9,200 intermodal containers and the necessary chassis to support this growing business. And we are acquiring 625 new covered hoppers. Probably the biggest change from prior estimates is that our 2010 PTC spending will only be around $100 million versus in $200 million originally targeted.

We remain committed to meeting the mandated installation dates but the deployment of this developing technology is a challenge. We have encountered delays in design work and material availability all related to the fact that this technology is not available off the shelf.

Another changes that we recently resumed to working on our Sunset Corridor which with plans to lay about 16 more miles of double track by year end. When this is cut over, the 760 mile route will be about 63% complete with more to come in 2011. Our mission going forward is to continue executing on disciplined operating plan that delivers a high quality efficient service product for our customers.

An important element in achieving that goal is to reduce variability in our network. Running a 3200 mile outdoor factory it means that Mother Nature and external forces can introduce any number of unplanned events on a daily basis. Because of that it's critical that we take the variability out of our operations and take charge of those things that we control. Along with increasing network reliability, we will continue our evergreen productivity initiatives, and of course everything we do to deliver efficient high quality service is done with a safety mindset making sure that everyone who works for does business with or interacts with us does so safely. So with that I will turn it over to Rob to take you through our financial performance.

Rob Knight

Thanks, Lance and good morning. Today we are following up our record second quarter results with an even stronger third quarter performance. Slide 22 provides a quick summary of third quarter revenues and expenses. Operating revenue increased 20% to $4.4 billion as operating expenses grew only 11% to $3 billion.

This translated into 46% operating income growth through a record $1.4 billion. Over the course of 2010, we have demonstrated strong volume leverage which is driving higher profits and better margins. Increased year-over-year diesel fuel prices have been the biggest cost driver for the year and contributed roughly one-third of the quarter's operating expense increase. Third quarter other income increased $11 million versus 2009 to $25 million largely as a result of lower environmental costs as well as higher licensing and rental incomes.

Interest expense totaled $153 million; down $3 million versus 2009 as average debt level were slightly lower year-over-year. Income taxes increased 62% to $495 million as a result of higher pre-tax earnings as well as a higher tax rate. Our third quarter 2010 effective tax rate was 38.9% which was 1.7 points higher than 2009. Net income was at quarterly best of $778 million up 51%.

Earnings per share increased to 54% to a $1.56 per share. Resuming our share we purchase program in May, reduced our outstanding share balance 2% in the quarter, enabling our earnings growth to outpace the rate of net income increases. Of course a key component of these strong results is a focus on increasing our core rail transportation pricing. Consistent with our discussions about improving prices in 2010, third quarter core price came in around 5.5%.

Our legacy renewals increased demand and quality service all support the strong value proposition of Union Pacific. Included in our core pricing gains is the impact of higher year-over-year fuel increases which contributed a little more than a half point in the quarter. This contribution level has been pretty steady throughout 2010. As we close out the year, we continue to feel very positive about our future pricing opportunities and are committed to achieving real pricing gains that will drive higher returns.

Now let's discuss the expense details starting with compensation and benefits at $1.1 billion in the third quarter, a 9% increase versus last year. Roughly half of the higher year-over-year expense relates to wage and benefit inflation. We're also seeing higher costs as trains starts increase, generating more starts for employees as well as paying more for overtime and training expenses.

In addition, equity and incentive compensation was a little higher year-over-year, driving about 10% of the increase. Offsetting a portion of these higher costs is our strong employee productivity. We handled a 14% increase in seven day car loadings with virtually no change in our total workforce levels. We did add about 9% to our train and engine ranks but that was largely offset by decreases in other areas.

Through a combination of our capital investments, technology and unified planned initiatives, we are handling more volume more efficiently. As Lance mentioned, we plan to continue recalling furloughed employees as needed for volume and attrition. We also anticipate further hiring as volumes grow and we exhaust the furlough pools across the system. Third quarter fuel expense totaled $608 million, a 30% increase versus 2009. Increased year-over-year fuel prices were the primary driver of the higher expense adding $97 million for the quarter. Higher volumes were also a factor adding about $42 million.

Our efforts to reduce overall fuel usage did help offset a portion of the quarterly cost as our consumption rate improved 1%. Slide 26 provides a summary of the third quarter expenses for three separate categories. Purchase services and material expense increased $52 million in the quarter or 13% to $465 million. Much of this increase relates to greater contract service expense associated with year-over-year volume gains. As our intermodal business continues to grow, trucking and lift costs are higher. And as we return more stored locomotives to service, both contract services and materials expense increased.

Equipments and other rents expense increased just 1% or $2 million to $292 million. The biggest increase in the quarter was car hire expenses associated with increased finished vehicles and intermodal shipments, largely offsetting this lower lease expense for locomotives and freight cars.

Other expense totaled $178 million consistent with the guidance that we previously gave you down $1 million versus the third quarter 2009. As we have discussed the last several quarters, this category continues to benefit from our strong safety performance. State and local taxes mostly driven by higher property taxes came in higher year-over-year.

For the fourth quarter, we think that other expense will be around the third quarter levels. UP's third quarter operating ratio came in at a new best ever level of 68.2%, 5 points, 6 points better than last year. This is our second consecutive quarter with a sub 70 operating ratio as we continue to drive improvements across all aspects of our operations. Our ability to efficiently move growing business volumes at better pricing and better fuel surcharge recovery is driving greater profitability for Union Pacific. This is consistent with our commitment to improve overall returns in our business as well as achieving the goals of our private operating ratio initiative.

Along with Union Pacific's increased profitability comes greater cash generation. Through the first nine months of 2010, cash from operations totaled $3.1 billion up more than $700 million compared to 2009. Free cash flow after dividends is up substantially as well, totaling over $1 billion even as we support our 2010 capital program and increased the dividend 22%.

We're also continuing to return cash to shareholders through our share repurchase program. We are being opportunistic with our program, buying back more than 14 million shares year-to-date for a total of over a $1 billion. Through September, our average 2010 purchase price was around $72.50 per share and roughly $65 per share over the life of the program. Our commitments to maintaining a strong balance sheet and investment grade credit rating are also still very much in focus. Our adjusted debt to cap ratio of 44% is in the range it supports the rating we believe is appropriate for our business. Let me rap things up with a few thoughts on the fourth quarter.

As Jack discussed earlier, we see solid year-over-year volume growth opportunities to close out 2010 even against our toughest comparison of the year. Of course normal seasonal trends are expected to hold which would likely produce a seven day volume run rate in the fourth quarter that is below the third quarter level.

With carload growth, we expect continued leverage although against a tough comparison as well. As you heard from Lance, we have largely depleted our furlough pools so it will be necessary to ramp up some of our hiring programs to handle more business as well as backfill for attrition. We also have the additional cost in more locomotives and freight cars and service as well as slightly higher fuel costs. Against those cost headwinds, we believe we can still achieve strong productivity as well as see the benefit of ongoing pricing gains.

Overall, we're looking forward to wrapping up 2010 with a strong fourth quarter performance. We're keeping an eye on the economy, particularly as we start putting together our plans for 2011. And while car loading activity certainly drives the direction of our earnings, cash flows and returns, we are committed to creating value for our shareholders. With that I'll turn it back to Jim.

Jim Young

Thanks, Rob. With just a couple of months remaining this year, it's probably safe to say that we are on pace to make this our best area for our railroad. As the economy continues to grow, we are ready to safely and reliably call more freight. The infrastructure investments we've made over the last several years enable us to operate more productively and with greater reliability.

With that comes better service for our customers which increases UP's value preposition and financial returns. The men and women of Union Pacific are dedicated to serving our customers, delivering the goods that are vital to our nation. It's been our business for almost 150 years and we look forward to continuing that success in the future. So with that let's open it up to your questions.

Question-and-Answer Session

Operator

Thank you. Soon I will be conducting the question-and-answer session. (Operator Instructions). Our first question is from John Larkin with Stifel Nicolaus. Please proceed with your question.

John Larkin - Stifel Nicolaus

Just wanted to get a little feel for the financial impact of Hurricane Alex it sounds like it was pretty disruptive down on the Mexican border, could you share with us how much that may have impacted the operating ratio?

Jim Young

Clearly there was an impact on the numbers but it was relatively minor on the cost I mean the bigger issue for me was maintaining the customer service and commitments to our customers or when you have that border closed we had many of our auto facilities who were at risk closing down because of parts and now our team did a good job of keeping things moving. We got a great feedback back from our customers.

John Larkin - Stifel Nicolaus

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

Jim Young

There is probably some shift as Jack had mentioned on the auto parts if you look at it, auto parts were flat year-over-year and some of that may have gone highway when you look at it but again it was relatively minor.

John Larkin - Stifel Nicolaus

Then maybe as a follow on perhaps for Jack. Jack had mentioned that the intermodal peak seems to be less than perhaps a little longer than you originally talked about. There has been a lot written in the press about the peak being pulled forward. Any thoughts as to when that's going to be tailing off and whether or not the retailers perhaps ordered a bit too much and will end up with overstock inventories which could potentially slow intermodal down as we get into the early part of next year?

Jack Koraleski

You know John, it's pretty early to tell the jury still out and whether or not they've ordered too much. What our intermodal ocean carriers have told us is at least some of them have told us they expect their ships to be relatively full for as much as another 60 days which usually by now you are starting to see the percentage of capacity starting to look down a bit, so that's pretty good news for us and we are watching very carefully in terms of the inventory sales ratios and things like that there is certainly nothing better that alarms us and tells us that we are going to be heading on a downturn here. So we are feeling pretty optimistic right now.

Operator

Thank you. Our next question is from the line of Edward Wolfe with Wolfe Trahan & Company. Please proceed with your question, sir.

Scott Group - Wolfe Trahan & Company

It's Scott Group in for Ed. If I look at margins of the past five or six years or so, fourth quarter tends to be a little bit better than third quarter. Rob, you talked about some cost headwinds coming in fourth quarter, do you think that dynamic place that differently this year and fourth quarter margins are worse than third quarter?

Rob Knight

I mean a lot of things can happen in the fourth quarter to us whether in volume is obviously will be a key driver. So, it's not always true that the fourth quarter is better, I mean in fact I think it's probably 50-50 to be honest if you kind of looked at a longer historical and recall that last year, we had a fairly sizeable, favorable adjustment on the PI, personal injury and asbestos So, we're not making projections in terms of how that's going to play out this year but just keep that in mind as you look at (inaudible) versus last year's fourth quarter.

Scott Group - Wolfe Trahan & Company

And then, Rob, I didn't hear the breakout of fuel and mix and overall on the business and I'm wondering if there was any negative mix impact in intermodal. I guess we were just a little surprised that yields or revenue per car was flattish from second quarter despite putting in some rate increases and some peak surcharges.

Rob Knight

Yeah, overall we said that fuel contributed to our overall arc about five points and there was overall negative mix of about three or four points which is a result of the strong growth in overall and intermodal and some of the mixed impact that Jack talked about in our industrial products line. Jack, if you want to talk about the intermodal specifics.

Jim Young

This is Jim. I think you need to look at the charge Jack had in there to join the core price numbers and that really takes the mix out of the equation. The fact of the matter is our core pricing numbers were up compared to second quarter. You really do have to watch with the mix on an average revenue per car basis as we committed our core price was up.

Scott Group - Wolfe Trahan & Company

And anything specific in intermodal?

Jim Young

If you just looked at intermodal, Scott, the only thing that was a mix impact is the strength of the international business where we still have a legacy contract impact there and that grew quite well in the third quarter which created some negative mix but we still had positive price in both our domestic and our international business.

Scott Group - Wolfe Trahan & Company

So that's stronger international is masking some of the strength that in the domestic rate increases you put out?

Jim Young

Yes.

Operator

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

Walter Spracklin - RBC Capital Markets

First question is on, you guys are doing a great job obviously on the operating leverage side with excellent productivity, I think Lance you mentioned best since seven years on the employee productivity, my question is on the sustainability of that and obviously you've run through your furloughs pool, you are going to be hiring, potentially hiring new employees that presumably need a little bit more training, what is the sustainability of your, of this operating leverage trend and do you think that productivity level gets worse with more volumes or stays the same or might even get better with higher volume.

Rob Knight

Sure, as we look forward, Walter, we don't see any reason why productivity can't be sustained now that doesn't mean that's fairly sustained at the same rate as we've seen through this year as volume first started returning. For the long run we anticipate we going to continue to be able to use our assets productively, both employees as well fixed assets.

Walter Spracklin - RBC Capital Markets

But some of those ratios could come down as we continue with higher volumes.

Rob Knight

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

Walter Spracklin - RBC Capital Markets

Okay

Jim Young

Its still going to be, Walter, there are still good ratios and I will give you an example, we are hiring now for next year. You are going to see more people in the classroom getting trained, its all assumption next year but and its not a linear relationship, the cost in this business are kind of the step function out here but even though you will see some of those cost increases we are still going to have very good leverage.

Walter Spracklin - RBC Capital Markets

Second question here, I guess Jim on regulation, obviously this is an election year, it's not going to be the re-reg Surface Transportation Board or Reauthorization Act is not going to be top of mind until this done. When you look out to 2011 and we know your positive view on rail and all the benefits of that offers, but what is your strategy when this starts to creep back up gain in 2011 and listen to what Rockefeller is saying about using regulation that supports the legislation. Can you talk about the railroad industry strategy in 2011 when this starts to re-surface again?

Jim Young

Well, it's really no different from where we have been the last couple of years. We are engaged with center to Rockefeller and the main item is tell a story. By any measure when you look at the success of deregulating the industry, it's an absolute great story. You look at new investment that's going into the industry. The private sector and if you agree, the country has an infrastructure problem; there's a lot of private money that's gone into new investments. So keep them engaged, provide great service, keep our customers engaged in terms of where investment is going and also point out if they get it wrong. We'll go backwards in investment; we'll go backwards in job, so…

Walter Spracklin - RBC Capital Markets

So, are you worried about the regulation strategy that he's talked about?

Jim Young

I have to tell you, when I think about the problems in this country, I have a hard time seeing where the issues in the railroad are in the top 50 list. It doesn't mean we don't pay attention to it and we stay focus and engaged.

Operator

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

Tom Wadewitz - JPMorgan Chase

Wanted to ask you a little bit about I guess train lengths, I think you've seen some nice expansion in train lengths particularly in intermodal this year and maybe where you're added you are going to next year, is there still a big opportunity to run longer trains and have a good ratio of volume growth to train starts. Or how would you think about that as a driver of leverage in 2011?

Lance Fritz

Tom our train length opportunities still exist as we go into 2011, specific to intermodal, we still have a upside, it depends on where the business comes in terms of the lanes in the quarter that those trains run in, but across the board, across all our product mix, we still have train length opportunities and it still will be an important part of our productivity and business.

Tom Wadewitz - JPMorgan Chase

Okay and lets see as a follow-up question, on the cost side when I look at comp and benefit, you had pretty good increases on a per worker basis this year. I think a lot of that is incentive comp but you also have transitioned to half year impact from a strong wage increase to this colder period while you're negotiating. How should we think about per worker cost next year when you consider wage and inflation? Is it kind of 2% to 3%, is it a little more than that? Presumably it's a lot lower than what you've seen this year.

Jim Young

Hey Tom, first of all, the increase is not a function of incentive comps a big driver. As Rob mentioned, it was of the increase third quarter about 10% of that growth. So take it off the table, yeah obviously we're finally recycling we had 4.5% percent increase on the labor agreement that's out here. We had a lot of overtime and we have been pushing the overtime curve here in terms of absorbing some of the volume that's out of here. Our healthcare cost have jumped up pretty substantially here in third quarter. You look out to the future; our inflation number that we look at it in that 3.5% to 4% range, that's the way you ought to think about. Now that again we still have productivity in our targets when you work in the railroad and your leading department is you offset inflation in terms of productivity, that's obvious.

Tom Wadewitz - JPMorgan Chase

But you are seeing 3.5% to 4% per worker.

Jim Young

It's going to vary of minx. Give an example, it looks what Rob was talking about earlier, we increased our hiring in terms and numbers on [TE&Y] train and engine crew employees. They have a tendency to have the highest average earnings, if you are out running on the railroads, then you can get a mix impact there that will drive that cost up also.

Operator

Thank you, our next question is from the line of Gary Chase of Barclays Capital. Please proceed with your question.

Brandon Oglenski - Barclays Capital

Hi, good morning gentlemen. This is actually Brandon Oglenski. Can we talk a little bit about export grains? I know the Russian moratorium came into effect around mid August. I was wondering if you know looking in the 4Q, if there is any equipment or port availability that's really going to limit the growth there. And then secondly, we've seen some activity in your grain tariff. I was wondering if you'll comment a little bit further about that.

Jack Koraleski

The second part of your question Brandon, I wasn't clear on.

Brandon Oglenski - Barclays Capital

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

Jack Koraleski

Yes, okay. You know at this point in time, in terms of equipments supply those kinds of things, we're pretty well equipped and ready to run as Lance said we pulled the C5's and some C4's out of storage. We still have a few more that we could if we need to.

In terms of overall port disruption, it tends to be episodic actually. There was a problem at the Port of Houston with an electrical outage for four days, some of those kinds of things but overall, ports seem to be running pretty well. So, I don't really see any major obstacles there. Probably Jack it did impact the velocity and if you look at the customer queuing piece in terms of grains.

Jim Young

But it is an episodic, its not something fundamental or from an infrastructure perspective that I think will be causing us to miss a forecast or not take advantage of the market opportunity and in terms of the tear up, we're watching that very carefully and we're taking opportunities to increase our rates as necessary and as available to us and being very careful as we think through our commitments to customers and also what the market's done.

Brandon Oglenski - Barclays Capital

And then, maybe just a little bit further on the labor side, I know you guys said you are going to be looking to hiring a few more people next year. I was wondering if you could balance that against the attrition level that you guys are expressing and maybe give us an idea of how headcounts should be trending.

Jim Young

We're going to loose our hiring this year; we're going to end up with about 1700 new hirers into the company. I would expect our fourth quarter employment levels probably to be up a little bit from where we were. We are flat year-over-year. Next year, our attrition numbers are going to run around 3,500 to 4,000.

We clearly are going to keep. Again, let's assume what are we thinking the economy next year, still pretty cloudy but I still believe we are going to continue kind of slightly positive as you think. So we're going to have a pretty strong hiring program and again, if volume's up and we're probably see our employment numbers up a little bit.

Brandon Oglenski - Barclays Capital

So, somewhat of a one-for-one match there on the attrition rate then?

Jim Young

Well, it depends with in some cases we are taking advantage of the attrition in terms of the productivity initiatives when you look at it, we won't hire again if you think what we are telling on the train side and productivity there you won't have a one-for-one with volume there. But again what your assessment, I am not going to make a prediction of volume other than I think its going to be positive and we will be up a little bit next year.

Operator

Thank you. Our next question is from the line of Jon Langenfeld with Robert W. Baird. Please proceed with your question.

Jon Langenfeld - Robert W. Baird

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

Jack Koraleski

Jon, the fundamental change that took place was early in the year when some of the ocean carriers decided the best course of business was to trans load at the port and then turn around and send the boxes back. So that happened nothing really substantive has changed as we have gone through the years, some ocean carriers allow their freight to move inland, others are preferring to trans load on the west coast.

We did notice particularly this quarter a stronger move of empty boxes back the revenue empties that we move to the west coast was much stronger we said basically they weren't willing to allow the containers to sit and look for a back haul load they would rather export that to Asia so they can turn the box again. But other than that there really hasn't been anything substantive change as we gone through the year.

Jon Langenfeld - Robert W. Baird

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

Jack Koraleski

Well, Jon in many ways other than an intermodal facility, it's all interrelated. When we look at for example our Sunset Corridor that Lance had talked about that we have started backup are going to do about 16 miles new rail this year. Other products moving that line, so you step back in that network and when we think the next three to five years you have to think that holistically how will all six businesses grow?

How do you manage the network in terms of the choke points? I'm pretty bullish when I think about the next five years for this business that rail is going to grow each share of total intercity business and we are going to invest accordingly. The key in this business is service and we want to stay ahead of that curve to provide great service, we see value in terms of our yield force and great growth.

Jon Langenfeld - Robert W. Baird

And indeed, that you see again on that horizon for the significant terminal build out beyond what you have already done adding on to existing facility?

Jack Koraleski

Well, if you are talking intermodal we have some targeted areas, we are looking at I mean we are out right now looking at property for the long-term and we think about what's happened with property values right now. Now is a great time to be in that market when you think strategically.

You can acquire property and send these vocations at $0.50 on the dollar from where it was three years ago. So we are making acquisitions today that we are looking three, four, five, six years out that we would need.

Operator

Thank you. Our next question is coming from the line of Chris Ceraso of Credit Suisse. Please proceed with your question.

Allison Landry - Credit Suisse

Good morning, this is Allison Landry in for Chris. I just had a question regarding the international intermodal you mentioned that you should be seeing continued strengths but the inbound container data for the ports of LA and Long Beach actually declined pretty significantly sequentially in September from August and I was wondering if you could kind of comment on that inconsistency?

Lance Fritz

Yes. You know I have not seen that in our numbers.

Jack Koraleski

Well, the only issue was in, but this would be in early October, the impact of the typhoon, the three day impact of the typhoon in Asia and then also the Golden Holiday in China but in the September timeframe I didn't see a significant impact on our numbers at all.

Allison Landry - Credit Suisse

Okay and then can you remind us when the legacy contract in international intermodal rose over?

Jack Koraleski

We don't get into individual contract discussions.

Operator

Our next question is coming from the line of Bill Greene of Morgan Stanley. Please proceed with you question.

Bill Greene - Morgan Stanley

I just want to follow up on the incremental margin question, it seems like there's an assumption that they will sort of come down from the 60% rate but you still have more business to re-price and arguably you could theoretically get more productive so is there a case for arguing that they actually stay or even accelerate from here, how do you think about the trajectory of incremental margin?

Jim Young

Bill, our comments on that margin were more related to what you think about the productivity levels. We certainly have our facilities on legacy pricing. We have opportunities in terms of when you look at demand but the discussion I was thinking about and as we are talking through is if you are holding pricing firm, how do you think about productivity expanding or contracting the margin and as we've talked earlier as you move up that capacity curve you are going to start to add a few more to costing. And then taking into account what will happen with the pricing numbers, I mean that possibility is clearly there.

Rob Knight

Just one of the points to keep in mind as we performed well throughout as the economy turned down the comparisons get more difficult through each quarter. That's just something else that there's a factor in that.

Jim Young

Well, and there's another piece there, as you think about we start to push up in that 190000 car range or 195000 what is that thing about overall demand which should say that the better pricing environment overall for capabilities so. Jack in his team have, you know Lance has the challenge of continuing productivity. Jack and his team has the challenge of continuing to drive prices up the reflect demand.

Bill Greene - Morgan Stanley

Okay. So that actually leads to that second question which is, you've talked for a while now about accelerating pricing and we saw that again this quarter. When does it sort of peak out. Are we there, is there more to go, given the legacy re-pricing and whatnot to come.

Rob Knight

Yeah. Bill let me, we just to kind of reset the table here, when we talk about accelerating pricing, that was when we had a 3.5% core price in the first quarter but we said at that point in time which is the only guidance we gave on pricing is that we expected throughout 2010 for that to increase and in fact that's -- in fact what we have seen 5.5% core price in the third quarter I think is evidence of in fact that expectation.

Bill Greene - Morgan Stanley

And you are not saying any things beyond that.

Rob Knight

No, that's right.

Operator

Our next question is from the line of Ken Hoexter with Bank of America. Please proceed with your question.

Ken Hoexter - Bank of America

Let me jump on the coal comments you made earlier. It sounds like you are noting some mining downtimes, some inventory levels being low, any chance for increasing coal export on the West Coast first and then second, it just seems like you're setting yourself up for some pretty improving demand on the coal side, is that what you'd anticipate?

Jack Koraleski

Ken we're probably going to do about a million and a half tons in export coal this year but we are working diligently with potential developers of port capacity which is kind of our biggest choke point to move off the West Coast and we're getting some bites there that we think are pretty attractive and pretty interesting. So we're hopeful that we're going to see export coal improve from the Union Pacific franchise perspective. So that will be a good thing and yeah secondly, we saw the impact that weather could have last winter when we went from 75 days, down to basically on plan from a stockpile perspective but right now the way things are shaping up through the first quarter, our coal demand looks pretty solid, much better than where we were a year ago and hopefully that will continue. I hate to say this, everybody in the room will throw daggers at me but I hope we have a nice cold long winter and that will help us again.

Ken Hoexter - Bank of America

Let me just get a follow up with Lance on the equipment side. You gave numbers for employees furloughed and cars, what about locomotives still in storage? Just wanted to understand how much you have left and then it sounded like you were reducing your spend on PTC. Is that I guess maybe for Jim, I'll throw it out there, I mean, is it something you are still working with the regulators to say, hey, the technology is just not there, we can't yet meet those deadlines or you would just keep pushing it back and hope things get developed in time for the 2015 deadline.

Lance Fritz

In terms of locomotives and storage we've got somewhere between 850 to 900. I'll remind you that those are older locomotives I mentioned in my comments. The average age is 26 years. We've got all of the DPU capable and high efficiency units out and running but we do have 850 plus that are available for that.

Jim Young

We did talk about; we are looking at maybe acquiring a 100 new locomotives next year, efficiency emissions requirements long-term that's out of here. On the PTC question, it's a combination of several things in terms of going from $200 to about $100 million, design resources just overall, the complexity of this system, has wounded deployment down a little bit. We are doing everything we can in terms of getting this thing to reality. The regulatory discussion or political discussion will I think happen more next year when (inaudible) is going to be required to kind of meet, we are going to also look at certain checkpoints and you'll look at the feasibility of technology that, unfortunately we're spending a lot of money to try to get it there.

Rob Knight

Our expectation is still in that $1.4 billion capital spend for us over the next several years.

Operator

Thank you our next question is from the line Cherilyn Radbourne of TD Newcrest. Please proceed with your question.

Cherilyn Radbourne - TD Newcrest

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

Jim Young

Cherilyn we are not giving guidance on future pricing other than, we think we have the capability to get real price. We are seeing very good yields on new products reporting in the marketplace that directly reflect the service that we put in. I am feeling pretty good about our capability. We have to perform service wise and we need to get the pricing up and returns up if we're going to justify the capital we are putting in.

Cherilyn Radbourne - TD Newcrest

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

Jim Young

We did quite a bit of research before we kicked the campaign off and guess what, we confirmed what you just said that in a lot of cases, customers have to believe that they don't have a track outside the warehouse, they can do business with railroad or if they don't think they are big enough in terms of doing business with railroad. Or we are tough to deal with.

The goal of the campaign, there is three objectives. One to really help a very large addressable market, understand that they do have an option for rail and that's a complete logistic solution. So we feel that there is a lot of capability there.

Second, I want to increase the awareness from the local mayor to state senator about how important rail is in terms of the business we do. As it probably would surprise you, many folks, their experience with rail is they are sitting out of sightings and they don't really see the clarity of how important we are.

And third for us is employee pride. We've got a lot of leverage going with service and lot of our employees are interested in how do we grow and add jobs into the company long-term.

So, those three factors come in and play. We have changed the organization, we have got an on boarding team, we have got a new website, terms call it micro site, terms what we are doing. Jack and his team have added resources. The worst thing you do is you put an ad campaign out and customer makes the call and you are frustrated. That's the easiest way to failure. So we are pretty pumped up at, in fact some of the earlier calls, a lot of this is not just intermodal when you think about the capability. There are some of the earlier calls where opportunities in the carload network.

Operator

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

Jeff Kauffman - Sterne Agee

Most of our questions have been answered already but we need a quick question on equipment run. On a GTM basis it looks like it was down double digit and 1Q and 2Q and mid single digit in 3Q. Kind of curious is that supposed to grow more in line with volume soon or how should we think about that?

Rob Knight

Yes, it should go with volume and you can have a mix effect depending on what equipment it is moving whether its equipment that in fact has rent associated with it or whether its something doesn't. And of course we are always focused on offsetting any increase in equipment risk with productivity. Bottom line is, it will grow with volume but there is a mix effect in there.

Operator

Thank you. Our next question is from the line of Anthony Gallo from Wells Fargo. Please proceed with your question.

Anthony Gallo - Wells Fargo

I guess it's a two part question that I'll count as two questions. Operating margins are 780 basis points better than they were in the third quarter of 2007. I think you said carloads are about 8% or 9% below that level. So if you can bridge us where we are today and then look ahead, price productivity costs were key components of the margin improvement over the last couple of years. How might that mix of those factors change going forward and would you care to bucket then for us historically?

Jim Young

I am not going to give specific guidance on the pricing, although clearly you go back two, three years ago we had a bigger book of legacy opportunity. So legacy in terms of driving some of the price was greater then than it is today. But again we still have a nice look at legacy business out there and as I said it earlier, we are seeing very good price capability for the service and value and products we are putting in.

So, it will be part of the equation going forward here may be a little less than we were in '07. But part of that is your assumption is where volumes are going. You get out there two, three years from now. If you believe as I do that rails got to have a greater share of intercity freight in the demand of growth. I think the pricing number could be pretty strong.

Anthony Gallo - Wells Fargo

Okay. And then on the productivity side is it fair to say that it wasn't meaningful in '07, '08 whereas right now its very meaningful, how do you want us to think about the productivity piece of it going forward?

Jim Young

As you may recall, we've launched an efforts called project operating ratio and in fact one of the things we think service extremely well if we launch that effort prior to the economic downturn, what that effort was as we lifted all 40000 plus of our employees to tackle everything they do from productivity to adding value to customer which we know is important to improve our service and add value on the pricing front.

So, we felt good coming into that economic downturn certainly by the time of later half of '08 came around. That was well underway and had a lot of momentum. So, yes we have made progress compared to that '07 timeframe but I wouldn't characterize that was the debt of our productivity either.

Lance Fritz

Can I have one thing, the other thing I noticed you look at our key measures from the operating perspective; we have been demonstrating productivity improvement steadily since 2007.

Operator

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

Rob Salmon - Deutsche Bank

This is Rob on for Justin. You guys have talked a lot in the past and on this conference call about the improvements you've made on the service front which have driven market conversion on intermodal in particular. How do you think about guaranteeing service levels in an environment where the ocean liners may no longer provide the chassis on intermodal and how do you think about that potential change affecting the intermodal landscape and the ability to provide the service.

Jim Young

Your call was breaking up, what was it, is it Rob.

Rob Salmon - Deutsche Bank

Yeah, its Rob, sorry I will repeat it. I guess you guys have talked a lot about the improvements you've made on the service front which has driven market conversion on intermodal in particular, how should we think about your ability to kind of guarantee service levels in an environment where the ocean liners may no longer provide chassis? And how do you think about that kind of impacting the overall network?

Jim Young

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

Rob Salmon - Deutsche Bank

Sounds good on that front and then if I look at the productivity measures, you guys drove some solid improvement on the gross ton mile per employee, even sequentially from Q2, could you give us a sense, if there is anything incremental that was implemented from Q2 or is it primarily the benefit of the volume leverage?

Jim Young

Well, I think the big piece of it is the volume leverage but if you step back a minute, it had also point it goes to things like our unified plan, it goes to our infrastructure investments we made over the years. It goes to coronation between marking operation and the products we're putting in. I mean this is a business that (levers) with volume to a point but you can also reach a point that you start to see negative productivity if you overload the network but the key is managing that network to its maximum efficiency point on the capacity curve.

Rob Salmon - Deutsche Bank

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

Rob Knight

From Q3

Rob Salmon - Deutsche Bank

From Q3 to Q4 rather.

Rob Knight

Yeah, and by the way in the third quarter it was a little higher when it was related to state taxes and the timing issues within some of the states, so looking forward I would bank on around a 38% rate.

Operator

Thank you. Our last question is from the line of George Pickral of Stephens Incorporated. Please proceed with your question sir.

George Pickral - Stephens Incorporated

Lance one question for you. Of the 30,000 containers, cars that are still parked, is there any one specific type that you may have more of the part versus another, I think you mentioned you are actually buying covered hoppers and intermodal container so I imagine you've got little to none of those parked right now.

Lance Fritz

Yeah the mix of what's stored right now in terms of freight cars varies of course you know with lumber down we've got a fair amount of cars that are used for transporting lumber. With the automotive finished goods down, we've got a fair number of auto racks that are stored. So you are right there is a definitely a differentiation in the type of cars that we've get stored.

George Pickral - Stephens Incorporated

What about coal.

Lance Fritz

Pretty de minimis at this point some but that's not a majority.

Jim Young

Hey George I think that's a good example when we start to think about productivity in the future. I think it's a good example where depending on where the growth comes if you have more leverage in other areas. Look at lumber, which as Lance mentioned we have had some of the flat cars our lumber loadings are only about 20% to 25% of where they were in the peak back in '06-'07. So, if you see your lumber business pick up, you should see pretty nice leverage on that particular group, you got excess equipment sitting around, we have capacity in our yards we still have our 111 principal yards, we got about 23, 24 that are very much under utilized so we got good upside there.

Operator

Thank you. There are no further questions at this time. I would now like to turn the floor back over to Mr. Jim Young for closing comments.

Jim Young

Well, thank you for joining us today. I hope you are happy with the results. We are going to continue to focus on improvement in this company and now look forward to talking to you in early January. Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Union Pacific Corp. CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts