Burlington Northern Santa Fe Q3 2007 Earnings Call Transcript

Burlington Northern Santa Fe Corporation (BNI)

Q3 2007 Earnings Call

October 23, 2007 8:45 am ET

Executives

Matt Rose - Chairman, President and CEO

Tom Hund - EVP and Chief Financial Officer

Carl Ice - EVP and Chief Operations Officer,

John Lanigan - EVP and Chief Marketing Officer.

Analysts

Tom Wadewitz - J.P. Morgan

David Feinberg - Goldman Sachs

Jason Seidl - Credit Suisse

Randy Cousins - BMO Capital Markets

Scott Flower - Banc of America Securities

Adam Longstan - Morgan Stanley

Edward Wolfe - Bear Stearns

Michael Wienz - J.P. Morgan

Chris Weatherby - Merrill Lynch

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the BNSF Corporation Conference Call hosted by Matt Rose. At the request of your host, all lines are in a listen-only mode. (Operator Instructions). As a reminder, this conference is being recorded.

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

Matt Rose

Alright, thank you Karen. Good morning everybody, welcome to our Third Quarter Financial Presentation. With me here in Fort Worth today are, Tom Hund, EVP and Chief Financial Officer; Carl Ice, EVP and Chief Operations Officer, and John Lanigan, EVP and Chief Marketing Officer.

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

I would also like to mention that we will be providing non-GAAP measures today in our commentary and ask that you refer to the investor relations webpage on our website for reconciliation to the GAAP.

Taking a look at our results for the third quarter, we are pleased to report earnings per share of $1.48. That represents all-time record quarterly earnings and an increase of 11% from the third quarter earnings per share last year of $1.33.

While we had benefit in the quarter of approximately $0.02 from recent developments in coal rate cases, these results were achieved in spite of a net $45 fuel headwind due to our expiring hedge position.

Freight revenue was 4% to $3.9 billion, due to continued strong pricing of about 6%, which was partially offset by mix. John will give you a detailed report of the results for each of the business units in his review.

Finally, we will report an operating ratio of 74.6%, which represent an improvement of more than a 100 basis points versus last year, which was the result of a very effective cost control and ongoing improvement in yields.

As always, Tom will provide you with the details of fuel and the other expense categories, and Carl will provide an operational update. Now I will turn it over to Tom.

Tom Hund

Thank you Matt, and good morning. Earnings per share in the third quarter were an all-time quarterly record of $1.48, which is 11% higher than the third quarter of 2006.

Quarterly operating income exceeded $1 billion for the first time, increasing by $80 million or 9% over 2006. And the increase in operating income was driven by freight revenue growth of 4% and strong cost control, especially in our largest expense category: compensation and benefits.

Third quarter operating ratio improved to 74.6% and decreased more than 100 basis points over last year. And as always John will cover the details of revenue, and I'll cover expenses.

Operating expense was $3.68 billion for the quarter, $50 million or 2% higher than the third quarter of 2006. A 4% decrease in compensation and benefits was more than offset by higher fuel, depreciation, and material and other expenses.

Compensation and benefit expense was $937 million, down $38 million, or 4% from 2006. Compensation and benefits expense for employees was down 3% on slightly lower headcount.

Wages and benefit increases were offset by lower variable compensation cost and other cost controls. Purchase service expense was $501 million for the third quarter and flat for 2006. Depreciation expense was $324 million, up about 9% from last year, as a result of our continuing capital investment.

Equipment rent expense was $235 million for the third quarter. The equipment rents were about flat for 2006, as higher locomotive rents were partially offset by reduced freight car costs. Material and other expense of $257 million was up $34 million over the third quarter of 2006. This increase was partially a result of the $16 million higher than normal environmental accrual. Additionally, a favorable settlement in 2006, higher material expenses and increased crew support cost were partially offset by lower personal injury cost in quarter.

And finally, fuel expense of $814 million was about 3% higher than the third quarter of 2006. The $22 million increase was driven by a reduction in hedge benefit of $75 million, partly offset by improved fuel efficiency of more than 3%. Looking little closer at fuel in the third quarter, average fuel price per gallon was $2.31.

Fuel expense reflected a $45 million headwind for the third quarter and the headwind was the net impact of the hedge benefit changes partly offset by increased fuel surcharge participation and slightly lower fuel prices. Now for the fourth quarter of 2007, we anticipate a net headwind of about $100 million and this increase over the last quarter's guidance was principally due to significantly higher fuel prices.

We expect fourth quarter total operating expense to be about $260 million or 9% higher than the fourth quarter of 2006, with fuel expense accounting for about $220 million of this change.

Interest expense for the third quarter was $132 million, and other expense for the third quarter was $6 million. The tax rate was 38.6%. Now, we still anticipate our capital commitments of about $2.550 billion and free cash flow after dividends of around $700 million for 2007.

Turning to share repurchases, we bought back 3.1 million shares in the quarter under our share repurchase program. And outstanding shares are down about 25% since the share repurchase program began.

Now, I'll turn it over to John for a detailed review of revenues by business units.

John Lanigan

Thanks, Tom. We posted an all-time revenue record despite continued economic softness leading to declining units and flat revenue ton miles. Three of our four business units, coal, Ag and industrial products achieved all-time revenue records this quarter. In addition, Ag had an all-time units record and coal had all-time record tonnage.

Overall, we delivered an improved revenue performance driven by yield quality, despite the slowdown in the US economy. Fuel surcharge revenue was down 2% due to the decline in units. The overall change in mix was primarily driven by an international revenue empties which was partially offset a favorable coal rate case adjustments.

Turning to the individual business units, while the quarter started off with flooding and washouts in the Midwest, we rebounded quickly, enabling coal to set an all-time revenue record and third quarter tons record.

Loadings per day in the third quarter were 55.6 system wide and 50.6 on the Powder River Basin. Our continued focus on efficiency resulted in an all-time high of 118.4 tons per unit driven by steel to aluminum conversions. September recorded an all-time trains per day record for the joint line.

We expect PRB coal tonnage in 2007 to exceed 290 million tons, which would beat all previous records. Even as we move record amounts of coal, utility forecast continue to indicate higher demand than what the mines are producing. During the quarter, two-thirds of the missed loading opportunities were mine related.

In our agricultural products business unit, we produced an all-time record quarter for revenue and units led by volume growth in feeds, fertilizer and ethanol. Overall gulf exports were up 26% during the quarter, driven by weed exports.

Due to a combination of mix and PNW elevator maintenance outages, PNW export volumes were down 10% with weed partially offsetting soybeans and corn. Ethanol volume grew significantly and also drove increased shipments of DDGs for feed usage.

Portions of our industrial products business continued to feel the impact of the economic slowdown in terms of unit volume, but still sustained an all-time revenue record in the third quarter, driven by improvement in yield quality. Building products revenue were down 10% compared to a decline of 6% in the second quarter as we saw the continued impact of the housing decline.

However, we saw strong demand in petroleum driven by Fuel by Rail. Chemicals and plastics benefited from strong demand in industrial chemicals with volume up 5%. Construction products produced 6% revenue growth, however volume was negatively affected as a result of weather related issues.

Consumer products revenue was down 3% on a 10% decline in units. International posted 3% lower revenue on a 14% decline in the volume, driven by the following three factors. First, on the import front, the decline in Eastbound loads was driven by the slowing US economy, which has resulted in a decline in Eastbound containers handled at West Coast ports versus the third quarter of 2006. We have not lost any major contracts this year.

Second, we saw the reduced TransPacific service of a major international customer, as we discussed last quarter.

Finally, while empty volumes continued to decline similarly to what we've discussed in the previous quarters, this decline was partially offset by the growth of Westbound loads on strong demand for US exports.

Similar to last quarter, the domestic segment reported a 4% decline in volume, reflecting the overall softness in the trucking market.

Due to the soft economy we are continuing to see slower volumes, and looking forward, we expect to see this trend to continue during the fourth quarter of 2007. However, we anticipate positive revenue growth, based on continued yield management.

In coal, PRB burn is up 5% year-to-date versus last year. The mines are off to a great start in the fourth quarter, and we are on-pace to set all time records. In Ag we expect to see continued strong wheat exports and a record corn crop combined with strong corn exports.

Ethanol will continue its growth as new plans come online in the fourth quarter. Industrial products will continue to feel the impact of the economic slowdown of the building products sector, offset by yield in revenue growth in the other sectors.

And in consumer, we expect flat revenue growth driven by yield improvement offset by softness in volume. So overall, we expect revenue growth in the mid single-digits.

Now I’ll turn it over to Carl for a review of operations.

Carl Ice

Thanks, John. Good morning everyone. Over the next few minutes we’ll be highlighting our premier focused areas.

Beginning with velocity. Locomotive miles per day were down slightly compared to the same period last year, but as you can see on the right, we improved each month throughout the year, and as you'll recall, we began the quarter with significant flooding issues.

In car velocity we were down about 7/10 of 1% over the last year. There were two basis issues. First, the flooding that I’ve already mentioned, which I will not bring up again because we are well recovered from that, and working through weather advances as a basic part of railroading.

Secondly, we’ve had congestion in our Gulf operation, primary resulting from the grain volume that John mentioned earlier, which exceeded the elevator capacity as well as IP growth. Those two together have taxed our facilities in the Gulf. But we’ve been aggressive about moving cars into the area because we wanted to capture the volume.

With our emphasis on velocity as you could expect, we’ve seen an ongoing improvement on our on-time performance highlighted particularly by coal.

Turning to productivity. Our workforce was down about 1% in the third quarter and we were down slightly in gross ton miles per employee. In the fourth quarter we expect to return to our long running improvement trend with about a 2% drop in employees.

In our inventory comparison, you can see that our inventory is up with a drop in the volume. There are two basic issues here. First, as I believe you all know, we’ve had more coal sets available through out the year then was necessary to move the volume that we are handling. So despite the fact that we’ve restored those sets, they show up in our inventory. And then secondly, private cars are up.

Beyond the measures, we thought it would be helpful to comment on the overall operation of the railroad. The railroads a are large and busy place, so to do that well, we really need to break it into our four segments. First in terms of coal, John’s already mentioned that we’ve moved a lot of coal, with that we’ve seen solid improvement in our cycle time throughout the quarter with several weekly cycles being the best we’ve seen in three years.

On the IP front, overall velocity is flattish, but the train velocity has improved and improved throughout the quarter. In our premium segment, we saw an improvement and good customer feedback, as well as improvement in some of our key lines.

In Ag, despite the issues I’ve mentioned, adjusting for staging were basically flat year-over-year, and over a several year period we’ve shown good improvement in AG and our unit growth has well outpaced our inventory growth.

And finally in industrial products. Each month of the year we showed improvement in velocity over last year until September, and in October we are making improvements in that area as well.

So finally, we thought it would be interesting to show you our fuel efficiencies. As you can see in the third quarter, we had an all-time record for gross ton miles per gallon of 803. So in summary, we continue to believe we have the right initiatives in place to drive improvement in our key focus areas.

Matt Rose

Alright, thanks Carl. Turning to our outlook for fourth quarter, we anticipate freight revenue growth in the mid single-digits due to ongoing effective yield management combined with an increase in fuel surcharges partially offset by mix.

With unit revenues expected to remain soft, we will continue to focus on the controlling cost through productivity initiatives and leveraging the variable components of our cost structure. We expect fourth quarter earnings per share to be about flat with last year, in spite of the $0.17 per share headwind Tom described.

So based on our current outlook, we will report an increase in earnings per share for the full year over adjusted earnings of $5 per share last year. And of course that's in spite of an economic slowdown that continues to affect both our industrial and our consumer product segments, and what we now predict to be a net fuel headwind for the year about $0.50 per share.

We've discussed the variability we’ve intentionally built into cost structure and advantages of our diverse revenue base many times in the past, and both of these elements of our franchise are working to our advantage in this current environment.

With that Karen I think we are ready to take some questions. Hello Karen.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Mr. Ken Hoexter from Merrill Lynch. Please go ahead.

Chris Weatherby - Merrill Lynch

Good morning. It's actually Chris Weatherby in for Ken. Just wanted to touch on headcount, briefly. Obviously you guys have been making some decent progress there. I just wanted to get an idea of where do you think you could see that going? I think you had mentioned down 2% in the fourth quarter year-over-year. What should we be thinking about for '08, assuming kind of volumes may be ramp up in the back half, but potentially stay weak for another quarter or two?

Matt Rose

Carl you want to…

Carl Ice

Sure. Well we are finalizing our '08 plans right now. So, I can't comment on it in detail. But, generally, as we develop those plans, if volume comes back we would be able to add people. We'll continue to manage our headcount towards volume and we have got several leverage to pull using attrition, using our workforce retention boards that are in place.

Chris Weatherby - Merrill Lynch

Okay. And I guess speaking on the cost side, thinking about materials and other. I know you guys mentioned I think an environmental accrual there. I was just wondering if you could break that out and then I guess think about how we should be thinking about that line item as just standalone going forward.

Tom Hund

This is Tom, Chris. Yeah. We said that we had a $16 million higher than normal environmental accrual related to really just a handful of sites. So, little bit usual there. I would call that just an abnormal amount. So, we would expect that this number should come down. The overall level of spend in that line item should come down next quarter.

Chris Weatherby - Merrill Lynch

Okay. And about that amount or something percentage of that $16 million?

Tom Hund

Well, we don't give guidance by line item, but certainly by that amount, if not may be little more.

Chris Weatherby - Merrill Lynch

Okay. And I guess just quickly, two quick other points. Just on the guidance, that's based on your GAAP 142 reported in the fourth quarter of '06. Is that correct or…?

Tom Hund

That's correct.

Chris Weatherby - Merrill Lynch

Okay, and then just finally, as far as legacy contracts kind of rolling over particularly on the coal side. Will you just comment on kind of what you have left? Anything that's being re-priced in the fourth quarter and then just kind of what's left after '07?

Matt Rose

John.

John Lanigan

We still have coal contracts, Chris, that have not come up for renewal out till 2011. So, we still have quite a runway left on legacy contracts.

Operator

Thank you. And our next question does comes from Randy Cousins with BMO Nesbitt Burns .Please go ahead.

Randy Cousins - BMO Nesbitt Burns

Morning, guys.

John Lanigan

Morning, Randy.

Randy Cousins - BMO Nesbitt Burns

John, wondered if you could comment or give us some more clarity in terms what's happening in your intermodal business? Obviously, it's the largest chunk of your business. You mentioned that a major customer of yours has been losing market share. Have you seen a stabilization, and do you see a situation where that customer potentially gains back some market share, are we continuing to look at relative deterioration?

John Lanigan

It wasn't a case of losing market share, it was case of them withdrawing from the market, withdrawing their service to market. So, that has continued out throughout the year. And from a standpoint of when we should left that, that will be about mid-year next year and it's really up to them to determine whether or not they want to come back into the market.

Operator

Thank you. And our next question does comes from the line of Ed Wolfe with Bear Stearns. Please go ahead.

Edward Wolfe - Bear Stearns

Yeah. Good morning

Matt Rose

Morning, Ed.

Edward Wolfe - Bear Stearns

Couple of things, JB Hunt reported volumes of 23% and intermodal volumes obviously are down a lot for you guys right now. How do we look at that discrepancy? How should we think about that since 83% of their volumes are on your line? How do we think about that?

John Lanigan

Well, I think, Ed, that they certainly have been very aggressive in getting share they share from their competitors. That would I think be the inference.

Operator

Thank you. And our next question does come from the line of Tom Wadewitz with J.P. Morgan. Please go ahead.

Michael Wienz - J.P. Morgan

Good morning, this is Michael [Wienz] actually in for Tom right now. How much further can go on pricing and what does spot market looks right now?

John Lanigan

We move very, very little business on the spot market. Most of our business is under contract and even the tariff business that we move, for example, an Ag doesn't change on a daily basis. So, within the railroad industry the spot market really doesn't have any impact on our pricing.

Michael Wienz - J.P. Morgan

Well, I mean, volumes are weak right now. They’ve been weak for quite a long period of time. Looking forward, if volumes don’t improve, like how much further can you go with price, before price starts to impact how much volume you have as opposed to just weak demand?

John Lanigan

I think it depends on how long and sustained the economic slowdown is, and that's difficult to predict. As lot of people are saying it starts to ramp up back in the second half of the year then I think we'll be able to maintain decent pricing going forward. But, if it becomes a very long and sustained downturn then we will probably have different discussions toward the end of next year.

Michael Wienz - J.P. Morgan

Okay. So, you are kind of expecting the same kind of things second half as possible time for pickup?

John Lanigan

Well it's hard to predict. At this point there are a lot of mixed signals in the economy.

Michael Wienz - J.P. Morgan

Okay. And my last question is, how much further can you go on productivity improvements given the weak environment?

Matt Rose

Carl?

Carl Ice

We'll continue to make productivity improvements. We would expect to have a coverage of half to two-thirds of inflation as we always do and we'll continue to drive productivity.

Michael Wienz - J.P. Morgan

Okay. Are there any specific areas that you can target on the cost side? I mean, it looks like you are able to reduce headcount this time that impacted comps and benefits. But, are there any other areas or is it going to mostly, initially be on the comp and benefit side?

John Lanigan

No, we will impact all areas. It will be across the board, but there are not one or two specific things I'd like to highlight, it’s work in all areas.

Tom Hund

And at this time I would certainly also add that it’s math because of the headwind and the price. But we made significant improvement in our, what I would call fuel efficiency which is gross ton miles per gallon in this past quarter, and it's an areas that we always push on.

Michael Wienz - J.P. Morgan

Alright. Thanks for your time guys.

Operator

Thank you. We have a follow up question from Mr. Edward Wolfe with Bear Stearns. Please go ahead.

Edward Wolfe - Bear Stearns

Hi. Guys. I am sorry I got cut off by the operator before. I started to ask about [Hund's] growth and you talked about them taking some shares. But those volumes tend to find their way on to your rail [road]. So what I was trying to understand was, is there anything to do with a change of import versus export? We are seeing obviously terrific export growth and weak import growth right now. Does that impact as you see your use of IMCs or the use of IMCs on your line?

John Lanigan

Not dramatically, certainly not at this point, Ed. The Westbound business is making its way primarily into international containers obviously, and all the international steamship lines have ramped up their marketing efforts in the US as well, and in many cases don’t rely as much on the use of IMCs as they might have five or ten years ago.

So, certainly some of the IMCs or doing well particularly smaller shippers, but the largest shippers have large programs in place.

Edward Wolfe - Bear Stearns

Okay. [Hund] talked about their retail customers seeing some weakness recently in the quarter. Are you seeing that with retail generally and what's your sense of retail season coming in?

John Lanigan

Well they've been pretty well chronicled themselves coming out and predicting relatively weak holiday seasons. A lot of the retailers have come out publicly and downgraded their growth numbers for the next quarter. So, it feels to us like that's playing out. It feels really like they are planning the inventory gain much tighter of the may be they have in the past.

And one of the big influencers added this whole use of gift cards and we've talked about it before. But the retail traders anticipating an increase of gift cards usage of 25% this year, and they also indicate that those gift cards don't spend until the following year, people don't rush out the day after Christmas and spend our gift cards.

In fact a lot on them are delayed until the first or second quarter waiting for the spring Easter type season, the spring clothing summer clothing coming out. So there has been some changes from that standpoint as well. In fact they think gift cards sales could be as much as $15 billion this year.

Edward Wolfe - Bear Stearns

When do you expect intermodal volumes to start to track up for you? Do we have the grandfather the [Maersk] situation or could that happen earlier you think?

John Lanigan

Well the [Maersk] situation was pretty significant to us, so we really have to get through that laughing situation mid-year, next year.

Matt Rose

And I think, Ed, also we've got understand where the housing sector's going. I think that while we traditionally don't breakout within intermodal, what really drives it. I think that there is a lot of spill-over effect into the general truckload intermodal of housing and housing-related type products.

John Lanigan

Yeah. Ed one of the revelations for the last few years is that the number one imported item from China the last couple of years has been furniture, and obviously with lower housing starts in the likes that's going to impact that particular commodity.

Edward Wolfe - Bear Stearns

That make sense. On that cost side you did a phenomenal job and I apologize if somebody asked this already. But salary and benefits down 4%, they were more flat last quarter year-over-year. Is that sustainable? How should we look at that going forward?

Tom Hund

Yes, this is Tom. Ed I think certainly next quarter we'd expect that trend to continue. And then as we move into next year I think it kind of really depends upon, what happens with volumes, and as Carl said we would expect to offset part of inflation, that’s obviously wage increases. We really expect to offset a substantial portion of that with the efficiency. So, you know, I think we [going] to next year it really depends upon kind of what we see volume wise.

Edward Wolfe - Bear Stearns

And so this is a good run-rate for fourth quarter and then next year we'll reassess and we’ll get better side. It's that a demand kind of thing?

Tom Hund

I think that’s fair.

Edward Wolfe - Bear Stearns

Okay. What was the fuel impact? You said for next quarter, there is a $0.17 headwind I think. What’s was the headwind in third quarter?

Tom Hund

I believe we said 40 -- was it 40 or 45…

John Lanigan

45.

Tom Hund

It was 45. This is the number we quoted.

Edward Wolfe - Bear Stearns

Million?

Tom Hund

45 million, yeah.

Edward Wolfe - Bear Stearns

Okay. Thanks a lot guys. I appreciate the time.

Tom Hund

You bet.

Operator

Thank you. And our next question is from Adam Longstan with Morgan Stanley. Please go ahead.

Adam Longstan - Morgan Stanley

Hi, gentlemen, thanks. I was wondering, Tom, could you give some more clarity just a follow up on the last question. On the reduction in variable comp in the salary line, how much was that, was that more than last quarter?

Tom Hund

You know, I don’t have the last quarter’s economy so I don’t know the number to that. But the year-over-year was probably worth at least a couple of cents per share.

Adam Longstan - Morgan Stanley

Okay. And was there any change in the mix of capital employees at all, that have might have impacted that number.

Tom Hund

Not materially.

Adam Longstan - Morgan Stanley

Okay. Okay. The other question I had was, you mentioned the congestion in the P&W. Do you have a sense for how much of the upside that might have taken away, especially with Ocean spreads where they are some, and some of the Gulf congestion that you said kind of resulted out of that?

Matt Rose

We didn’t mean that. I don’t think we meant to say congestion in the P&W. What we said was that the elevators were basically shut down for an extended period of time, almost 30 days.

Adam Longstan - Morgan Stanley

Okay.

John Lanigan

The congestion that we saw on the railroad was really in the Gulf Coast area.

Adam Longstan - Morgan Stanley

Okay. And how long was the elevator down, I am sorry.

Matt Rose

They were down about 30 days

Adam Longstan - Morgan Stanley

About 30 days. Okay

Matt Rose

Yeah

Adam Longstan - Morgan Stanley

And then just the last question, on the intermodal side alot of people have mentioned here about pricing pressures potentially on the domestic side from the trucking companies. And then on the international side, there has been a lot of talk in the industry about the Mayor's contract, obviously. And then that some volumes may be shifting over to lower price legacy contracts on some other carriers. Does that make you rethink your pricing strategy in your terminal?

Matt Rose

Well, we are always trying to calibrate our pricing strategy with what's going on in the marketable short and medium term. So, you know that's a continual process for us and we'll continue to look at that as we move forward.

Adam Longstan - Morgan Stanley

Okay, great. Thanks a lot guys

John Lanigan

I think from a longer standpoint it's a great question. I mean, at the end of the day if intermodal we believe will continue to grow, there's going to have to be capacity put in. And quiet frankly, the market rates that we are charging to date simply reflect that that cost to put that additional capacity in. I mean, we literally have spent hundreds and hundreds of millions of dollars of expanding intermodal franchise. So, there really are a few choices. We could have chosen not to make the expansions and not to include that in those base rates. But, at the end of the day we know that the marketplace wants us to continue to be able to handle these volumes.

Adam Longstan - Morgan Stanley

Right, right.

John Lanigan

Over the long-term.

Adam Longstan - Morgan Stanley

Okay, great. Thanks a lot.

John Lanigan

You bet

Operator

Thank you. And our next question does come from the line of Scott Flower with Banc of America Securities. Please go ahead.

Scott Flower - Banc of America Securities

Yeah. Good morning all.

Matt Rose

Good morning, Scott

Scott Flower - Banc of America Securities

Yeah. Just a couple of other questions. And forgive me I came out little late if some of these have been addressed. But, Matt, could you give us some sense of how you see things playing in Washington. There is lots of moving parts and pieces. And obviously, I understand some of the economics of the business, but political side, obviously, economic may not totally play to those audiences. And so, I am just trying to get a sense of, there is so many moving parts and pieces both in Congresses as well as STB. How do you see the political environment in Washington affecting how you see the business in '08?

Matt Rose

Well, Scott, I think we can all agree that there is more activity in Washington on railroad regulatory policy then we've seen in quite a while. And in terms of the ability for a bill to come out of the committee or come out of the one of the two Houses and Congress, I think there is a much higher chance. But, at the end of the day we think that the question will be asked, regardless of who is in power of the White House or the two bodies, the question that will be asked is whether or not these actions will result in more real capacity. And I think clearly that is the issue that's not come forth today. What is coming forth today is primarily reduction of rents from the railroad industry to the customers.

But, it really comes down to the fundamental question of who's going to pay for the renewal of the railroad industry and who's going to pay for the expansion of the railroad industry. You probably saw that the industry just came out with a study looking at the next 30 odd years and Cambridge did a third-party study and came out with about $150 billion that is going have to be invested in the industry. Now, that's not renewal, that's simply expansion to be able to be handle about a 3% type CAGR growth.

So, these are a tremendous amount of resources that are going to have to go into the industry. And whatever regulatory policy is adopted it's going to have to be a policy that it inseams that investment. And so, I think what you are seeing right now is a lot of frustration from shippers who over the last 20, 25 years have seen ever reducing rates and now as we have reached this equilibrium of demand and supply, are starting to see rates go up because of the renewal process that the railroads are going through, as well as the capacities have to be expanded, and there is a lot of frustration.

And so, it really comes down to the fundamental question of how this infrastructure will be paid for. So, I think you have to kind of keep in perspective of the hearings and the bills that are out there. There is a hearing today in the senate and you will hear a lot of frustration, but at the end of the day a question that will have to be raised of what regulatory policy will inseam these investments to come into this industry.

Scott Flower - Banc of America Securities

Okay, and then just a couple of other quick ones. And maybe directionally, because I know given the sort of cycle of budgetary consideration this may not be done yet. But, I mean given that you all have tweaked your CapEx budgets down modestly a little bit this year based on what's going on in the economy, how should we directionally, and I said there word directionally, because I know you don't have precision, but how should we directionally think about CapEx for next year?

John Lanigan

Scott, I mean we haven't finalized anything and it will depend on our volumes. But, again CapEx you going to have to look at over a couple of years, Scott, because we have already got some projects that are started this year that we are going to do next year kind of regardless of what we think the economy is going to do, because these are long live projects. But, I think if you look at it over a couple of years, if volumes are expected to be soft for a couple of years you'll see the capital come down. There may be a short-term timing issue of six months or a year, because of projects that are started this year and that we choose not to stop. But generally what we've said is, as long as we see ever increasing returns which will in part be driven by ever increasing volumes then we'll continue to invest in the railroads. And if we see one of those two issues either ever increasing returns or ever increasing volumes start to diminish over the long return, you will see our capital come down. And I think that's only logical and makes sense for every body.

Scott Flower - Banc of America Securities

Okay, and then last question. And again forgive me if this has been addressed. But obviously I think Tom answered a question earlier about sort of the run rate and overall labor cost. But when I look it at a cost per employee [we've lost] something to tune of about 3% this quarter, which was demonstrably better than past quarters.

Is that something as per an employee basis? It was a mix driven, was it obviously incentive comp accruals, was it all above and should that sort of rate per employee also stay down at about that same kind of rate or how should I think about labor?

I just think there are some moving parts and pieces there, and I am just kind a get a better handle on it.

John Lanigan

This was clearly our, I don't know, I guess I'll say our best quarter from a comp stand point. And you are right, with a lot of stuff in a 90 day period that can impact it, this type of run rate I don't think is sustainable. But I think if you probably look at may be on a per employee basis more flat to down very slightly.

Scott Flower - Banc of America Securities

Okay, great. Thanks very much all.

John Lanigan

Thanks Scott

Operator

Thank you. And your next question is from Randy Cousins with BMO Capital Markets Please go ahead.

Randy Cousins - BMO Capital Markets

Nice to get a second chance. Again coming back to the intermodal, John, I wonder if you could give us some greater sense in terms of granularity, in terms of like I am looking at the average revenue per unit in intermodal. So, obviously, the international is up quite dramatically, and the domestic soft. Can you give us a sense as to sort of what's triggering those relative changes and how much is the loss and sort of the revenue empty business impacting the rates that we are seeing on your consolidated numbers?

John Lanigan

On the international side, as Matt talked about a couple of minutes ago, we've worked very hard to get that business up to a reinvestible level, because of the long-term growth prospects for that business. And so, those are obviously the result of contracts that we have been able to achieve over the last few years and they've played their way through the contract cycle.

On the domestic side, there is some mix changes going on in the background. The expedite truckload part of our business is down somewhat more than other parts of the business, that's reflective of what's going on in the overall trailer marketplace, and what's going on with trailer base carriers. So, part of it is a mix issue. We do have some modest price increase on the domestic side, on the same store basis, but the mix within that domestic intermodal kind of hide that a bit.

Randy Cousins - BMO Capital Markets

Okay. So, when I look at this [1206] year-over-year, the vast majority of that is baseline price increase, it’s not a mix issue or revenue empties that aren't there?

John Lanigan

Yeah. Well, the revenue empties are not there, and that obviously has an impact. As revenue empties move at a far lower rate then loads do, so that tends to make that yield or the RPU somewhat artificially high based on historical perspectives.

Randy Cousins - BMO Capital Markets

But, so again, still the majority of that increase is base increases rather a mix issue?

John Lanigan

Well, there is a lot of mix with the revenue empties situations, so that's part of the mix story as well. So, you can't negate that.

Randy Cousins - BMO Capital Markets

Okay. One last question, with reference to the Gulf exports, if the business comes back into the Gulf, does that have a more favorable impact on profitability -- or excuse me, comes back at the Pacific Northwest, does that have a more favorable impact on profitability than business going out through the Gulf?

John Lanigan

Well, that really depends on the timing and what's going on in the world market side. The Gulf has been so busy because of the rest of the world having a very poor wheat crop and so the Gulf is being drawing a lot more wheat than it normally does. And the commodity prices as everybody has followed had been going through the roof overall in Ag. So, the world supply and demand situation has really played out this year in the way that normally has not played out in the past.

Matt Rose

Randy, let me give you the shorter version. We would rather go PNW for infrastructure reasons as well as profitability.

Randy Cousins - BMO Capital Markets

And so I guess, Matt what the real question is, what are the chances of getting that PNW business back, or is it a case where we've seen a shift that it just going to keep on going out through the gulf?

Matt Rose

It's back. It's screaming back today. I mean it's alive and well as we speak. I mean we are having, I shouldn't say record, we're having tremendous PNW export flow right now. So it's back and as John said, we don't drive these things. It's really around world markets and what the ocean spreads doing in all. But, we have a lot more unencumbered assets in the PNW and we have a lot better flow, our operating cost are more controlled there. And so, we love the environment we are in right now, which is a heavy PNW flow.

Randy Cousins - BMO Capital Markets

Okay. Great. Thank you.

John Lanigan

And the Gulf is still busy.

Matt Rose

And the Gulf is still busy.

John Lanigan

I mean the green markets are just playing busy, but there is been a lot of infrastructure investment in the PNW over the last number of years, and not as much in the Gulf and that sort of exacerbated the issue this year.

Operator

Thank you. And our next question does come from the line of Jason Seidl with Credit Suisse. Please go ahead.

Jason Seidl - Credit Suisse

Hey. Gentlemen, sorry I jumped in a little bit late, so these are repeats, I apologize. Matt, do you have any comments in relationship to the new Safety Bill that just passed through the White House?

Matt Rose

Jason, there is a bill that will go through the senate and until that thing gets in confidence, we will just see where it goes. I mean, there is not a lot of things that are helpful in the house bill, and quite frankly we don't think that there is a lot of things that will add a lot of value overall to our shippers or to our company. So, again, it's a long way from passage and these things typically will work themselves out.

Jason Seidl - Credit Suisse

Okay, fair enough. And as a follow-up to that on their call CN talked about being close to obtaining second shipper for Prince Rupert. Do you anticipate any problems in terms of them stealing some business away from the ports that you serve along the West Coast?

Matt Rose

We don't know. Certainly we know that that facility is up there, but again we think that long-term there will be enough international growth that all those ports are going to be quite frankly fully taxed. And Rupert's got a narrow slot of what will work to certain markets, but it not just the nature of the CN franchises. It does not offer the breadth of diversity in terms of destination that the shippers are going to need long-term for every time.

Jason Seidl - Credit Suisse

Matt, as always, I appreciate the time.

Matt Rose

You bet.

Operator

Thank you. Our next question is from David Feinberg with Goldman Sachs. Please go ahead.

David Feinberg - Goldman Sachs

Good morning, gentlemen.

Matt Rose

Good morning

David Feinberg - Goldman Sachs

Two questions, with regard to the compensation declines that you had experienced year-over-year, I want to make sure I understand what's going on with the headcount. Is that just a higher rate of attrition that's allowing you to scale down your workforce or you are actually having to buy individuals out that contract?

Matt Rose

No, we are not buying anybody out. It's not a higher rate attrition. It's that we flex our workforce up and down with volumes and volumes have been soft, so we haven't added and we've allowed the workforce a trip out.

David Feinberg - Goldman Sachs

What is the current rate attrition?

Matt Rose

It's about 2%.

David Feinberg - Goldman Sachs

Okay. And then with regards to the share buybacks, in the second quarter it looked like the pace of share buybacks had accelerated. You've come back little bit here in 3Q. How should we think of the pace of share buybacks as we look forward as it relates to your program?

Matt Rose

Well. Sure. What we've said is our debt to cash flow, call that EBITDA or EBITDA minus maintenance it doesn't matter that much, because they move somewhat in exactly the same pattern or our interest coverage. Those are the kind of ratios we're looking at. We're looking at holding those recently constant with what we were at the end of the year. And so, you really got to look at that, say what's the borrowing capacity and then you'll come up with the number.

But, I mean, there was no intention to say that second versus third to be materially different. I mean, that's just timing, I guess within the quarters. And sometimes their certain windows when we can't buy, and things like that. So, that's a little bit of timing.

David Feinberg - Goldman Sachs

Okay. And can we just confirm what's left on the program over the time and when it expires?

Matt Rose

Well, there is now expiration on it. It's probably roughly 30 million shares left on it. We have plenty of run rate here.

David Feinberg - Goldman Sachs

Great. Thank you.

Operator

Thank you. And our last question is from Tom Wadewitz with J.P. Morgan. Please go ahead.

Tom Wadewitz - J.P. Morgan

Yes. Good morning. Just one question or two question on the yield side. I think you talked a little bit about what boosted coal yields in third quarter. Is there a dollar amount you can attribute to the rate case impact? And also when we look at forecasting coal yields going forward, does that continue where we go back to more of a kind of 9%, 10% growth if we look at fourth quarter?

Matt Rose

We said on the coal rate cases that it was a couple of cents per share on the coal rate cases. John you want to answer that?

John Lanigan

Yeah. And I think with that, obviously, that's a one-time deal, so we go back to basically what we've been doing in the last few quarters.

Tom Wadewitz - J.P. Morgan

Okay. And on Ag yields would you expect some acceleration in fourth quarter as you got some of these I guess favorable mix with more PNW? Would you expect stronger Ag yield growth in fourth quarter?

Matt Rose

Well, it's some very, very strong now and has been for the last couple of quarters based on all the growth dynamics, so it would be tough to predict depending upon how the quarter actually plays out. There is still a lot of moving parts, but historically it should be very strong.

Tom Wadewitz - J.P. Morgan

Okay. Thanks for the time.

Operator

Thank you. And there are no further questions. Please continue Mr. Rose

Matt Rose

Alright. Thanks everybody for your interest and we will talk to you again next quarter have a good and safe day.

Operator

That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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