Burlington Northern Santa Fe Corp. Q4 2007 Earnings Call Transcript

Burlington Northern Santa Fe Corp. (BNI)

Q4 FY07 Earnings Call

January 29, 2008, 8:45 AM ET

Executives

Matthew K. Rose - Chairman, President and CEO

Thomas N. Hund - EVP and CFO

John P. Lanigan, Jr. - EVP and Chief Marketing Officer

Carl R. Ice - EVP and Chief Operations Officer

Analysts

Edward Wolfe - Bear Stearns

Ken Hoexter - Merrill Lynch

Randy Cousins - BMO Capital Markets

Jason Seidl - Credit Suisse

John Barnes - BB&T Capital Markets

William Green - Morgan Stanley

Thomas Wadewitz - JP Morgan

John Larkin - Stifel Nicolaus

David Feinberg - Goldman Sachs

Walter Spracklin - RBC Capital Markets

Gary Chase - Lehman Brothers

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the BNSF Corporation Conference Call, hosted by Matt Rose. At the request of your host, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. 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.

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

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

Our presentation today is available by webcast, so I'll start by directing everyone's attention to our first slide, regarding forward-looking statements. This statement basically cautions everyone that any forward-looking information presented here today can be affected by a number of factors, which could cause actual results to differ materially from forecast information we provide. I'd also like to mention that we will be providing non-GAAP measures today in our commentary and ask that you refer to the Investor Relations page on our website for reconciliation to GAAP.

Taking a look at our results for the fourth quarter, we are pleased to report quarterly earnings per share of $1.46. That represents fourth quarter earnings and an increase of over fourth quarter earnings per share of last year of $1.42. These results were achieved in spite of $125 million or $0.22 per share fuel headwind, primarily due to higher fuel prices, a $32 million reduction in our fuel hedge benefits and the lagging effect of our fuel surcharge program.

Freight revenue increased 9% to a record $4.1 billion due to the continued strong pricing of about 6% and higher fuel surcharges driven by higher fuel prices, partially offset by mix. We experienced fuel revenue growth in each of our four business units against very strong results in the prior year. John, will give you a detailed report of the results for each of our business units in his review.

Our operating ratio for the fourth quarter was 76.9% and would have been about 300 basis points lower, if you would exclude the impact of the fuel surcharge on both the revenue and the expenses.

We made significant progress on service and productivity initiatives in the fourth quarter and Carl, will provide you with details as well as the preview of the 2008 capital program and Tom will provide you with details on all the expense categories.

Turning to a recap of the full year results; we reported earnings per share of $5.10 or $5.24, excluding the $0.14 first quarter charge for the environmental expenses and the technology system write-off. We achieved record freight revenues of $15.3 billion based on strong yield improvements despite 3% lower unit volumes. And for the second year in a row, free cash flow before dividend exceeded $1 billion, and after dividends free cash flow was $738 million. Return on invested capital was 10.5%. While we are not satisfied with the return of capital 10.5%, it was a solid result given the economic slowdown we've experienced and the significant fuel headwind we faced in 2007. We continue to believe in long-term growth potential of our franchise and we're committed to improving our returns in 2008.

Now I'll turn it over to Tom, who will review our fourth quarter expenses. Tom?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Thanks Matt. Earnings per share was a fourth quarter record of $1.46, which is 3% higher than the fourth quarter of 2006. And this increase as Matt said is despite $0.22 fuel headwind, which I'll cover in more detail when we get to fuel expense. Earnings per share for this quarter included a $0.02 tax adjustment, favorable tax adjustment and a similar amount was included in last year's earnings.

Quarterly operating income was $950 million, increasing by $7 million, or 1% over 2006. And the fourth quarter, operating ratio was 76.9%. The year-over-year increase is driven by the fuel headwind. As always, John will cover revenue and I will give the detail on expenses.

Operating expense was $3.295 billion for the quarter, $356 million or 12% higher than the fourth quarter of 2006. Lower compensation and benefits expense was more than offset by higher fuel depreciation and purchased service expenses. Compensation and benefits expense was $979 million, down $15 million from 2006. The compensation and benefits per employee was about flat on a 1% decline in headcount.

Wages and benefit increases were offset by lower variable compensation under our incentive compensation and profit sharing plans as well as other cost controls. Purchased service expense was $513 million for the fourth quarter, up 11% from 2006. About 20% of the increase is driven by our growing BNSF Logistics Company, which is offset in other revenues, and the remainder is due to higher haulage, partially resulting from increased agricultural volumes as well as higher locomotive and freight car maintenance.

Depreciation expense was $340 million, up 13% from last year, as a result of our continuing capital investment as well as from depreciation studies on existing assets. And these studies have generally increased our depreciation run rate modestly, due to our increased velocity and volume growth over the past several years.

Equipment rents expense was $238 million for the fourth quarter, up 1% from 2006.

Material and other expense of $265 million was up $20 million over the fourth quarter of 2006. This increase was mainly the result of higher environmental accrual and modestly higher freight car and property tax expense.

And finally, fuel expense of $960 million was about 37% higher than the fourth quarter of 2006. The $257 million increase was driven by significantly higher fuel prices and a $32 million reduction in hedge benefit, partially offset by improved fuel efficiency of more than 3%.

Looking little closer at fuel in the fourth quarter, average fuel price per gallon was $2.59 before hedge and $2.57 after hedge. Fuel expense reflected a $125 million headwind for the fourth quarter and this headwind is the net impact of higher fuel prices and hedge benefit changes, partially offset by increased fuel surcharge participation. The increase over last quarter's guidance is principally due to higher fuel prices.

Now, we expect first quarter 2008 total operating expenses to be up about 15% from the first quarter of 2007 on a GAAP basis or about 18% higher when excluding last year's unusual items for environmental and technology. About three-quarters of the expected increase is due to higher fuel prices.

Interest expense for the fourth quarter was $126 million and we expect first quarter 2008 interest expense to be about $140 million, primarily driven by increased debt levels. Other expense for the fourth quarter was $1 million and the fourth quarter tax rate was 37.2%. And we expect the first quarter... the fourth quarter tax rate was 37.2%, we expect first quarter tax rate to be a normal level of about 38%.

Our free cash flow after dividend for the year as Matt mentioned, was an all-time record of $738 million, driven by strong cash from operations and free cash flow before dividend exceeded $1 billion for the second year in a row. Finally, we achieved return on investment of 10.5%.

Turning to share repurchases, we bought back 3.4 million shares in the fourth quarter under the share repurchase program and for the full year, we bought back over 14 million shares.

Now I will turn it over to John for the review of freight revenues by business unit.

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

Thanks Tom. Despite continued economic softness, we posted an all-time record in freight revenue during the fourth quarter. Coal and Ag achieved all-time freight revenue and unit records, while Industrial had a fourth quarter revenue record and Consumer had an all-time record revenue quarter. In addition, Coal had an all time record tonnage.

Overall, we delivered an improved revenue performance driven by yield quality, despite the slowdown in the U.S. economy. Total fuel surcharge revenue in the fourth quarter was about a $120 million more than a year ago, driven by record fuel prices as well as increased customer participation in the fuel surcharge program. The overall change in mix was primarily driven by international revenue empties and lumber shipments.

Turning now to the individual business units; the fourth quarter was an all-time record for Coal. In November, we set numerous volume and revenue records. The all-time record loadings per day in the fourth quarter was 56.6 system wide and 52.1 on the Powder River Basin. And we continue to focus on efficiency. During the fourth quarter, we saw tons per unit improvement due to steel to aluminum conversions.

In our Agricultural Products business unit, we produced an all-time record quarter for revenue and unit, led by volume growth in wheat, milo, soybeans and ethanol. Overall, PNW exports were up 37% for the quarter. Overall Gulf exports were up 27% during the quarter, driven by wheat and milo exports. And despite strong corn PNW exports, corn was flat overall due to offset in other corridors. West Texas and Mexico were down because the large local crops in both areas reduced the need for inbound rail shipments. Corn exports to the Gulf were also down. And ethanol volume grew significantly as plants continue to come online.

Despite portions of our Industrial Products business being impacted by the continued economic slowdown, we still achieved a fourth quarter revenue record, driven by improvement in yield quality. This quarter was also the first, since the third quarter of 2006 that Industrial Products unit growth was positive.

We saw a strong demand in petroleum driven by fuel by rail and record LPG revenue. Construction Products produced 12% revenue growth led by steel, minerals and aggregates. Building products revenues were down 9% compared to a decline of 10% in the third quarter as we saw the continued impact of the housing decline.

Consumer Products revenue was up 2% on a 9% decline in units. International posted a positive revenue increase despite a 15% decline in volumes. The volume decrease was driven by the following three factors. First, eastbound load declined due to the slowing U.S. economy; second, we continue to be impacted by the reduced trans-Pacific service of a major international customer as discussed in pervious quarters. We didn't lose any major contracts last year. And finally, while we continue to see growth in westbound loads on strong demand for U.S. exports, total westbound units were down. This was due to lower import volumes and continued reduction in westbound revenue empties as we discussed in pervious quarters as well.

Domestic Intermodal reported a 4% increase in revenue on a slight drop in volume. Overall softness in the trucking market continues. And our Auto segment with 4% revenue growth continues to focus on yield improvement.

Due to the soft economy, we are continuing to see slower volumes and looking forward, we expect to see this trend continue during the first quarter of 2008. However, we anticipate positive revenue growth based on continued yield management. Additionally, as a result of higher fuel prices, fuel surcharge revenue will also increase.

In Coal, PRB burn is expected to increase over last year and BNSF is well positioned to handle growth. In Ag, we expect to see continued strong PNW, corn and soybean exports. Wheat in the PNW and Gulf exports are expected to be flat as high prices are discouraging additional demand.

Domestic shipments will pick up beginning in the second quarter as new Ethanol plants come online. Industrial Products should continue to feel the impact of the economic slowdown in building product sector, offset by yield and revenue growth in the other sectors. And in Consumer, in spite of soft demand, we expect to see modest revenue growth, which should improve during the year as eastbound trade improves. So overall, we expect revenue growth in the low teens.

And now, I'll turn it over to Carl for a review of operations.

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

Thanks, John. Good morning everyone. In the next few minutes, we will be discussing our familiar focuses of velocity, service, productivity and asset utilization.

We've had strong operational performance and you'll see that reflected in the upcoming metrics. First, in locomotive velocity, we continued our two-year trend of improvement, with improvement over both fourth quarter of '06 and the third quarter of 2007, with the best performance of the period. Car velocity is a similar story with even more improvement. We had a 4% improvement over third quarter of 2007 and a 1.5% improvement over the fourth quarter of 2006, and once again the best performance of the period.

As you would expect with those kinds of improvements, we also saw improvement in our service. We had the best long time performance we've had since the fourth quarter 2003... I am sorry, that's fourth quarter improvement since the fourth quarter 2003. We expect to see continued improvement throughout this year as we remain focused on our key initiatives of line and terminal throughput, train network design, train size, locomotive distribution, and maintenance reliability.

Turning to productivity, in the fourth quarter our workforce was down about 1% versus the same period in 2006. As a result and as we discussed last quarter, we saw improvement in employee productivity and in the fourth quarter, we set an all-time record per GTM per employee. We expect this to continue through 2008.

We did see an increase in our online inventory, primarily due to the growth in Ag and merchandise that John mentioned. We did have favorable comparisons in both of the areas especially in Ag, where our volume growth was about twice that of the inventory growth. The overall results were impacted by the reduction in volume of our fastest turning equipment, the Intermodal equipment.

In fuel efficiency, we achieved an all-time fourth quarter record of 773 GTMs per gallon, up 3.5% from the same period last year and our second consecutive quarter of record productivity.

Finally for 2007, our capital commitments were $2.59 billion and we anticipate 2008 capital be $2.45 billion. That $150 million decrease is driven by a reduction of expansion capital.

So in conclusion, our focus remains on service, velocity, asset utilization and productivity. We're confident that we have the right initiative in place as evidenced by the improvements we've made and the improvements we expect to have this year.

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

All right thanks Carl. Turning to our outlook for the 2008, we expect freight revenue growth in the first quarter in the low teens, with about half of that coming from fuel surcharge and other half coming from price. We currently expect first quarter earnings per share growth in the high single-digits for adjusted 2007 earnings of $1.10 per share, which excludes the $0.14 per share charge for the environmental expenses and the technology system write-off. This is despite a fuel headwind of about $0.10 a share based on the current forward curve. Finally, as Carl indicated, we expect to see our service and productivity improvements from the fourth quarter continue into this year.

Turning to the full year, we currently expect to see freight revenue growth in the high single-digits. Our revenue outlook assumes unit volumes are about flat, or give or take 1% or 2% for the rest of the year. Pricing is firm, but slightly less robust in 2007, and year-over-year increases in fuel surcharge revenue moderate as we lap the 2007 run up in fuel prices. Even with the general uncertainty about the economy, we believe low double-digit growth in earnings per share is achievable.

As Carl stated, we've again reduced our capital program to $2.450 billion based on our volume outlook and the capacity on our network. Once again, free cash flow should increase to around $800 million, after dividends. As I mentioned earlier, we're committed to resuming our trend of improving our return on invested capital.

With that, Sandy, I think we are ready to take some questions.

Question And Answer

Operator

[Operator Instructions]. Our first question is from the line of Edward Wolfe with Bear Stearns. Please go ahead.

Edward Wolfe - Bear Stearns

Hey good morning everybody.

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

Good morning Ed.

Edward Wolfe - Bear Stearns

Hey, just for a little clarification; the outlook, the double-digit earnings. That's on a base of what for '07 are you using?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

That's on a GAAP basis of 510.

Edward Wolfe - Bear Stearns

Okay.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Or is it? Marsha hold on, I am looking at Marsha for a second here. Let's go back on this, exact quote.

Edward Wolfe - Bear Stearns

While you are looking that up, can we talk a little bit about yields?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Hold on, it's off of the 524 Ed. It's off of the 524, which was excluding the $0.14. Yes, Okay sorry about that. Yes, go ahead.

Edward Wolfe - Bear Stearns

And while we are at it, let's do the first quarter then, what are you basing the first quarter '07 off of?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Adjusted, it's the same thing.

Edward Wolfe - Bear Stearns

All 10.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Yes.

Edward Wolfe - Bear Stearns

Okay. The yields are up so much; I mean even if I take a $120 million out for fuel, I've got yields up over 9.5%. Where there some contracts that came up during the quarter? How do we think about what led to the big acceleration year-over-year, quarter-over-quarter on fuel, in yields, I am sorry?

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

I think it's a combination Ed, we do have contracts that come due every quarter and again we've been on a long range trend of positive pricing performance. So, I think a combination of mix and yield improvement led to the performance.

Edward Wolfe - Bear Stearns

I thought mix was down 3, did I get that wrong?

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

Well it depends on the individual business unit. For example, in Consumer Products and International Intermodal, the mix and change in revenue empties is actually a positive from a standpoint of RPU.

Edward Wolfe - Bear Stearns

Okay. So, you said in the quarter 6% real pricing. How should we think about that in '08?

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

Well, we're going to continue to have firm pricing going into '08. We don't like to forecast pricing because we do have some moving parts, but we certainly plan to continue our long standing improvement in yield.

Edward Wolfe - Bear Stearns

Directionally, though should they come in a little, go up a little, flattish?

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

I think what we said that it would be... it will be in that range but probably not quite as robust as it... as it was 2007.

Edward Wolfe - Bear Stearns

Okay. Can you talk a little about export coal and whether there's any ability for you to benefit from that trend right now? We're seeing lot of strength around the world in coal.

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

We do have a little bit of export coal that goes out through Roberts Bank, down to South America at this point, it's relatively small number compared to what goes on of the East Coast ports.

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

I think yet our probably our biggest opportunity will be as the Eastern guys export more, there will probably be... that will force supplies up of Eastern coal as well as little less supply in it, that should allow PRB to infiltrate a little bit further east.

Edward Wolfe - Bear Stearns

So in other words, some market shift and some strengthening in yield overall, is that the way to think about it?

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

Yes.

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

Yes.

Edward Wolfe - Bear Stearns

Okay. On the export grain side; is there any way to give a sense of what the export grain tonnage was in '07 and what the potential is in '08?

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

We don't specifically talk about the tonnage Ed, but in '08, it... part of it, depends on the crop. We think that there's been a fundamental change in the world markets and the rest of the world being able to supply the growing demand in developing countries like China, in India, as they continue to change their diet. So we do think long-term, we've got great prospects for export grain and lot of its going to have to do with the quality of the crops this year, as to what those numbers actually look like.

Edward Wolfe - Bear Stearns

What's the capacity to add on to, I mean do you have the ability if the demand is there to really utilize and how should we think about that?

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

Yes we certainly have the capacity to grow or export grain capabilities.

Edward Wolfe - Bear Stearns

Matt, just shifting gears, the UTU just announced that they settled with the railroads tentatively and they have also talked about now instead of opposing tax credits supporting them. Have you heard anything about the potential to try to tuck something in for tax credits into Bush's stimulus plan, can you give an update on that?

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

You know Ed, we are obviously participating in and working with people, but right now there is lot of moving parts to it, whether or not its how much business tax stimulus will be in there? What we have seen so far is that it's generally around more accelerated depreciation on a shorter term period. So, right now we are not really hopeful that the investment tax credit itself can get in, but they are trying about a second bill and your guess is good as mine, whether or not that will actually happen.

Edward Wolfe - Bear Stearns

Is it your sense with the UTU changing their position that there is a real chance over the next 12 months to get something in the form of infrastructure passed or does it still feel like an election year, a long shot?

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

I think it's a tough long part for this year, and it's going to... it's a little bit longer process of what we are going to have to go through.

Edward Wolfe - Bear Stearns

Okay, thanks for the time, I appreciate it.

Operator

Our next question comes from the line of Ken Hoexter with Merrill Lynch. Please go ahead.

Ken Hoexter - Merrill Lynch

Great day. I am just... good morning. One follow-up question on the previous questioning, but on the export side, is there, when you have such a major shift of flows and increasing exports, I guess maybe not on the Ag side where you've kind of built the network for exports, but as you look maybe some consumer goods or other industrial goods may be moving overseas. Did that shift a fact kind of how that network is organized and perhaps kind of the expenses built around that at all?

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

Not really, because we always had particularly in the Intermodal side that flow of empty equipment going back to the West Coast because of the imbalance of trade when the dollar was stronger so the fact that we've replaced some revenue empties going westbound with revenue loads for export, it really doesn't change how we handle the freight.

Ken Hoexter - Merrill Lynch

Okay, thanks. On the gross ton miles for employees, I think that Carl was talking about, if I remember right, it used to be somewhere around 4% to 5 % annually, now it looks to be about I think you noted about 0.5%. Is there any thing that you're targeting or can get that back up to that kind of mid single-digit efficiency improvement levels?

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

We don't expect to be to be that high this year, I mean I think we are little more than 0.5%.

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

We were 1.5% actually the numbers.

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

GTMs up about two and we were down above one and the employees was met so there were normal levels in there, about 1.5. So I don't think it will be at four or five, but we expect to different in 08 is that we won't have the follow-up as we did earlier in 07 when we caught up. So we should show improvement every quarter and something similar year-over-year.

Ken Hoexter - Merrill Lynch

So do you see continued headcount reduction if volumes remain at Matt's target of flat levels?

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

Yes, I always adjust our workforce to what our volume is, we would expect that to happen. Depends a little bit on how gross ton miles move in relation to the volume.

Ken Hoexter - Merrill Lynch

Okay. And then with now that I guess most of the major contracts are pretty much wrapped up, have you... does it provide you anymore flexibility to be more cost I guess, reactive when you see these volumes slowing?

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

There isn't any thing in the contract that changes that, but again we are positioned with all of our work groups that we can make adjustments if need be. We rebalance the near term, we are needing employees so we don't hire people and furlough but we can furlough if it is necessary we did do retention boards last year to the whole sum of the people we had hired and we'll use that some of those people this year, so nothing really new in the contracts.

Ken Hoexter - Merrill Lynch

Right. And my last question is just on the yield side. If I just look at a couple of products or commodities I guess, on International Intermodal up 18%, Coal up 15%, and Ag up almost 10%. Those increases seem to be may be a bit more than some of the others so, I guess is that due to your ability to capture fuel quicker in those segments or is it... is there something else in there, just more pricing contracts within those segments during the quarter or anything affecting those?

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

The big thing in international Ken is the reduction in revenues empties and then somewhat partial offset with westbound export loads and so that just have a huge impact on RPU for that international segment. In Ag, it was just the ability to capture what the world markets were asking for in the run up of the commodity prices as well, so I think we really had a lot of positive aspects from an RPU standpoint that came into play in the quarter.

Unidentified Company Representative

And then for Coal came in like, you're starting to finally see fuel really bleed into the RCAP numbers and so for the customers that we have fuel surcharges with, we're collecting fuel surcharge with the customers that we don't have surcharges with that, we are subtracting with RCAP, you are starting to see RCAP finally recognized what's happening on the fuel basis.

Ken Hoexter - Merrill Lynch

Great stuff, great job in a tough environment, thanks a lot.

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

Thanks.

Operator

Our next question comes from Randy Cousins with BMO Capital Market. Go ahead.

Randy Cousins - BMO Capital Markets

Good morning.

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

Good morning Randy.

Randy Cousins - BMO Capital Markets

The question with reference to real estate, I believe you guys include that in the materials in other lines. Can you give us a sense as to what that number was in the fourth quarter, what the outlook is for real estate in 2008?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Yes we usually don't break that up, but it's not a --

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

Don is looking it up, always looking it up.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

It's not a significant number.

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

I will tell you, it's not a lot and it's not a lot in 2008.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

No, No it's not.

Randy Cousins - BMO Capital Markets

Okay. The second question with the coal, you guys had a number of initiatives out there to put new customers on the line. I wonder if you can give us a sense of what you think organic growth is from your existing customer base and what you see in terms of growth with new customers and who are starting out facilities or switching to Powder River Basin coal.

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

Well, we look at overall growth rate in 4% to 5 % range for this year and it's a combination of organic growth, some new business and then some increase in current customers. For example, we got one plant that was doing more importing of coal that has now shifted back to some PRB. So you might consider that organic growth, but it was tonnage that was going some place else before. So it's really a combination of all those and we think it's in the 4% to 5% overall range this year.

Randy Cousins - BMO Capital Markets

And Matt, you mentioned that you thought there might... you may not have the direct export opportunity, but there might be an indirect opportunity. If the growth rate in coal volumes is greater than 4% to 5%, you guys have the capacity to move 6% to 7% additional ton.

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

You know Randy, we will, I mean we always layer in our capacity ahead of when that demand's going to be there. We... as you know, we've got pretty good tools in terms of our Coal business, in terms of how much capacity is on the joint line and then how much capacity is available out there, so we think that the plant we got for the PRB, the joint line as well as what's off the PRB could easily accommodate that type of growth, if it presented itself.

Randy Cousins - BMO Capital Markets

Okay. Last question for Tom, just as a reference to the depreciation, you had a big jump in the fourth quarter; it is lot higher than the third. For modeling purposes, can you give us a sense that what we should budget for depreciation for 2008 or some indication as to our quarterly run rate?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Yes, it's probably going to be up, I am going to say probably about $40 million as we would look to the first quarter, as we talked about both the capital additions as well as the depreciation studies, probably three-quarters of the increase is due to the additions and a quarter is due to the impact of some of the studies that we are doing now.

Randy Cousins - BMO Capital Markets

Okay. Great, thank you.

Operator

Our next question is from Jason Seidl with Credit Suisse. Go ahead.

Jason Seidl - Credit Suisse

Good morning gentlemen.

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

Hi Jason.

Jason Seidl - Credit Suisse

Questions for Tom. Tom on a cash capital of $2 billion for this year, any chance that changes if the stimulus package passes the 30% bonus depreciation number?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Sure, I mean it's probably for both Matt and I, but I mean, I think as we did the last time, there was a bonus depreciation package put in, we pulled forward some of our capital and actually last time it was locomotives more than anything else. But we'll react whatever the stimulus that is put out there, both the... I will say the impact of the stimulus as well as the timing. Clearly, there is the opportunity to do a few things if the economics justify it.

Jason Seidl - Credit Suisse

So this number that we are seeing here does not assume that this stimulus package includes 50% bonus depreciation number?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

No.

Jason Seidl - Credit Suisse

Okay, now that's fair enough.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Yes.

Jason Seidl - Credit Suisse

Question for John. John, can you talk a little bit about any export collectivity from PRB coal, are we seeing any of that?

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

Yes, there is a little bit, as I mentioned earlier going through Roberts Bank down to South America. But again it's really closer to a rounding year than it is a significant amount for us.

Jason Seidl - Credit Suisse

Okay, so that, you don't foresee that actually becoming a new potential markets for PRB coal?

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

Well, it could be, but at this point, it's not one that's taking off in anyway. It's really more of shorter term opportunities that come up in South America at this point.

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

We think long-term Jason, there's a significant opportunity. We've got some challenges. We don't... we really don't have the export coal facility capability, capacity in terms of... we got Roberts Bank, but it's probably somewhat close to being at capacity. And so we're finding out how to work with that, but if you look at the long-term needs of the coal, it's kind of the same story as the Ag business, where china is being such a huge exporter of coal for so many years, as their industrial economy and as their consumer economy grows, they are going to be retaining a lot more of that coal, just like they did with their grain and that's going to displace a lot of that, of that coal fulfillment in other parts of Asia. And we do believe there is significant opportunities, but it is a challenge on, from terminalling and then right now ocean spreads, things like that.

Jason Seidl - Credit Suisse

Is there something that could change, if the stimulus packages does pass because the useful tax life on those facilities is much longer lived I think than your tracking your locomotive assets?

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

I don't think it's really that so much as finding and sighting and building the right type of coal export terminal that works from the water standpoint.

Jason Seidl - Credit Suisse

Okay, fair enough. And question for either Matt or John here, how do you see pure price trending through 2008. Is it going to be any different than the 6% we've seen in '06? And as a follow-up, what percentage of your contracts for '08 here are locked in?

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

We think that pricing won't be quite as strong as '07. But we think, still think it would be historically very strong. As far as our contracts locked in for '08, of all the business that we have under contract we probably have 70%, 75% of that locked up.

Jason Seidl - Credit Suisse

Okay, fair enough. I will let someone else at it. Thanks a lot gentlemen, good quarter.

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

Thank you.

Operator

Our next question is from John Barnes with BB&T Capital Markets. Please go ahead.

John Barnes - BB&T Capital Markets

Matt on, an obsolete question on CapEx. If the sluggish volumes were to continue throughout '08 and into '09, what kind of change... how aggressively would you go to reduce the $2.4 billion in capital expenditure in 2008 and in what magnitude might you... might you pull those down?

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

John, it depends, if the volume spread equally or not. I mean in this case, we're reducing the expansion capital in '08 versus '07 but we are going to, we just said, we're going to handle 4% to 5% more coal volume. So it... that the problem with it, it never quite comes exactly where you want it. And it never leaves you exactly where you want it to leave. And so the bottom line now is what we've said all along, is that as our network runs better, we won't need as much as the expansion capacity and if we saw a continued period of softness for a year or two years, you'll see us continue to take the dollars out of that expansion capacity. That's just... we've said that for a number of years, as we've gone up in the capacity expansions and our returns justify, you will see us bring it down as volumes want the lower capacity expansion.

John Barnes - BB&T Capital Markets

Okay. A follow-up question on the pricing. Just your comments about it, not being as robust in 08 as it has been in the last couple of years. I mean, is that just... is it more tough comparisons that you are up against because you had such success and so much of your business has been re-priced and so now you're just settling into a more normalized kind of rate increase environment. Or is there something else out there as if truckload competition on Intermodal or something like that which is causing you to be a little bit more conservative in that forecast?

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

No, I think it's a lot of thing. It's not just one single thing, but certainly, as we've gone through a re-pricing of the book, over the last three or four years that starts to wind down to some degree. But we still believe that long-term price is going to be in the 3% to 4%, when we look at our business model, quite frankly because of some of the inflationary indexes that we will see coming into the business. And so, we can argue, it's not going to be a 6% or 5%, but it's what we need to achieve in terms of prices still going to be in that 3% to 4% and that's what we think will the long, longer term type of range.

And then what you will see it as right now, we are definitely in a excess truck capacity situation as that... as those excess trucks are sucked out of the market and as the gross ton miles for the economy start to come back, you will see truck prices come back up, be much more aggressive on the truck price. And then you will see where our businesses compete with trucks, specifically in our Intermodal and some of our industrial, you will see those prices outpace the average of our overall pricing for the company.

John Barnes - BB&T Capital Markets

Okay. And then lastly, you answered the question earlier about some of this... even this tax credit and that kind of thing making it into stimulus package. I'm kind of curious, I mean, if it is... first, kind of thing you hung up is an election year issue. What is your outlook on some of the other rail legislation that's pending, the Safety Bill and some other things? Are you, are you in a position now where you think may be there is lesser chances of some of that getting through this year because we are in a bit of election year or do you think the focus is still there to get all that legislation pass?

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

Well I think the Safety Bill is a little different because it's been through both the committees; it's ready to go to conference. They have... they haven't taken it to conference. Depends on where that all ends up, it's got some things in there that we don't think are helpful. But generally, there are some things that we think we can work with as well. So the Safety Bill, we'll just have to see if they decide to take it to conference or not, as far as the things like the Rereg bill that haven't been through the full bodies, I think that those are a little harder in getting those through in election year, a little more distraction. But quite frankly, I also think it's harder when the business model for the railroad industry is actually working. And that is where the railroads are spending record capital amounts and as you know, you've seen all the capacity studies and we just released a... the surface transportation commission report that talked about the long-term needs of the highway system the railroad system.

We released a rail infrastructure report, the Cambridge Report last fall, that talked about the roughly $150 billion we need to spend over the next 30 years. And so, I think people are struggling with well these bills that are more destructive to railroad investments. How does that work in an economy where we need more rail capacity? So I think people are really pausing, they know that they are hearing some frustration from customers and trade groups specifically about rail issues, but one plus one, doesn't necessarily add up to passing a rail Rereg bill. So I think that's really the issue that's harder than whether or not it's an election year or not.

John Barnes - BB&T Capital Markets

Okay, all right. Hey nice year, thanks for the time.

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

Thanks.

Operator

Our next question comes from William Green with Morgan Stanley. Please go ahead.

William Green - Morgan Stanley

Yes, good morning. I am wondering if you can tell us how much of your business hasn't yet re-priced in this new year? And how much below market you think it might be?

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

We really have virtually gone through everything in our business with the exception of some coal business we have some longer term contracts in coal. So, in essence, in all the other business units we've gone through, at least once if not twice and maybe coming up on a third time depending upon the business. So we really have kind of gotten pass that phase where we look at... wonder if the book of business re-price, with the exception of some long range coal contracts.

William Green - Morgan Stanley

And how much are those, how much... what percent?

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

It's probably about 15% to 20% of our coal business.

William Green - Morgan Stanley

Okay. And then how do you think you can replace some of this International Intermodal that has moved. We had previously heard that you won some domestic Intermodal business. I am just curious if you had to discount to win that or how exactly you are going to replace this.

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

Well, we'll replace the International Intermodal business when the economy picks up and import start to pick-up. I mean it's really as simple as that. As we've talked at last couple of quarters, we had a major customer last year that made a strategic retreat to the rear from the trans-Pacific trade because of their economics and that was our largest international customer, so put a big hole in our volumes. And so we're anxiously awaiting the economy to perk back up and we'll see those imports try to pick-up and as far as that domestic customer, long-term customer who have majority of their business with us and they simply decided to move additional business to us, in order to make their network more efficient, more effective.

William Green - Morgan Stanley

So you didn't actually have to face any kind of pricing discounting to get that.

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

It was really a decision that the customer made in order to make their network work better.

William Green - Morgan Stanley

Okay thanks.

Operator

We have a question from the line of Tom Wadewitz with JP Morgan. Go ahead.

Thomas Wadewitz - JP Morgan

Yes, good morning. Wanted to follow-up a little further on what Bill just asked you about, I guess if you look that the Schneider business that you have taken from UP. I know, you already had big chunk of it, but that having been said, it looks like a pretty significant size, piece of business, it's going to move over to you in 2008. I wanted to see if Matt, if you could give us some more... a little more of the logic behind it because just at a high level, it kind of looks like 2002, 2003 type of approach where you had excess capacity and you went after some business to fill capacity. Just wondering if you can give a little further thought on that and is this pretty isolated or is there risk that there might be other areas of the book where you would say well we got some capacity so we will be a little aggressive in trying to fill that?

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

Tom, we are just not going to get into commenting on any specific customer issue. Customers make decisions based on their book of business all the time and that's just as far as what we are going to say.

Thomas Wadewitz - JP Morgan

But in terms of what if you don't want to focus on the specific customer, do you think the approach here would apply to some other customers or should we view this as pretty isolated in terms of the factors that drove that move of business from UP over to you?

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

I don't know, you would have to talk to customers. I mean, what we have demonstrated is our services gotten better; we are making the returns that we need to make to reinvest in the property. But we don't know what goes in to minds of customers when they decide to make a switch. In this case, this was a longstanding customer we had, we had the majority of his business already on us and he chose to put more business on us and that's really as far as what we're going to say on it.

Thomas Wadewitz - JP Morgan

Okay. Let's see, in terms of some of the expense drivers, it looks like there was I guess a number I see ex-fuel is expenses, operating expense up something like 4, a little north of 4% and volumes are off some. I am wondering if you can I guess give a sense of whether some of that inflation ex-fuel is something that's just hard to get around. I know you've a decent productivity and labor, but how do we think about the inflation in the business? And... what would maybe cause that to diminish a bit again looking ex-fuel?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Well Tom, in a couple of areas... I think there are some things that are a little of abnormalities. I mean if we... I talked about our BNSF Logistics business, which is... there, we reflect that in other revenues increases and in other revenues and increases in purchase services and so that's clearly gone up, probably I must say $10 million, something in that range on a year-over-year basis, and so that's outside of the... that your rail operating.

When I talked about depreciation and the studies and the fact that we're up $40 million roughly in this quarter and expect to be next quarter, it's going to take us a couple of quarters probably till mid-year next year where we lap those studies and come down to a more normal run rate and may be been up $30 million. So it's probably as I said a quarter of that is due to the studies, which is probably a little bit of a catch-up because of the velocity and the additional volumes that we put on versus when those depreciation rates will set, based upon our filing with the STB. And all in all, that's a good thing. I mean that's just saying, we are using our assets more frequently and getting more velocity out of them. So I mean those couple of things, I think are probably a little bit abnormal and then the final thing I talked about in material and other, I mentioned that there was a higher environmental accrual. I mean that hit us for probably about $0.02 a share, just really related to one or two specific sites and I would expect that to moderate to more normal levels.

So I mean, I think if we cut those things out, probably that basket I just gave you, is probably $30 million - $35 million something like that. So that's certainly in the range of a nickel or something like that and I think we are down to really to an inflation offset by initiative type of number.

Thomas Wadewitz - JP Morgan

What about on a per worker basis, what do you think that number looks like in '08?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Total comp, compensation benefits?

Thomas Wadewitz - JP Morgan

I am sorry, in terms of compensation and benefits if you look at on a per worker basis. I think you had some benefit and in terms of reduction on incentive payout, but, presumably that won't be as big factor in '08 and just wondering on a kind of per worker basis, is it up three or four, is it up one?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Well, actually on the incentive plans, we would expect that, that becomes a headwind for us next year. I mean because this year we clearly did not make our plans and so we probably had a couple of cent a quarter benefits, which is the way it should work. I mean when, not doing as well then that's something that should happen as we expect to get back to plan. That's going to cause a bit of a headwind, as we look to next year --

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

That again Tom, that on about 25% of our schedule workforce and the exempt workforce.

Thomas Wadewitz - JP Morgan

Okay.

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Yes. So, as we look to next year... I mean... probably expect headcount to be somewhere between flat to down very slightly and then we'll have... obviously the normal cost inflation offset by initiatives, but then we are going to have the headwind of the incentive compensation so we certainly going to be up several percent on a per employee basis.

Thomas Wadewitz - JP Morgan

Right, okay, all right. Well nice quarter and thank you for the time.

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

Thanks Tom.

Operator

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

John Larkin - Stifel Nicolaus

Good morning gentlemen.

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

Hi John.

John Larkin - Stifel Nicolaus

Had a question on the volume comps and when you may think they would turn positive. I think you said they're going to be flat as far as you could tell for the first quarter, but you did allude to truckload fleets taking some capacity out, we are seeing that pretty much across the industry. Also there is awful lot of stimulus coming forth, both in the form of monetary and fiscal policies stimulus. Any thoughts that perhaps the second half might return to a more normalized volume growth rate?

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

John, this is John, we do think that in the second half of the year we will start to move northward from a volume standpoint. And the big event for us is lapping the decision by that major international customer to exit the trans-Pacific trade. We lap that after the second quarter so, we are kind of looking at that third quarter timeframe to start to make some improvements.

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

John I think, what your comment is kind of hinting around is that there are lot of moving parts in terms of truckload capacity and this kind of economy won't take much in terms of GDP growth to get gross ton miles coming back on all these networks. And I think that the thing that people... I won't say you guys but, I think the thing that the people really can't quite get a feel on is the sea changes that we saw over the last five to seven years in terms of gross tons miles. They came on all these networks. And if you just look at our network alone from call it 2002, we are still probably up 25% to 30% in terms of units. It's been huge unit growth and all that excess capacity that really we had during the late 90's and in the early 2000 was just really sucked up and so we when we talk about steel having a very tight network, very clearly see that on our network very much so, and then when you start thinking about 5% more tons for something like coal and then you start thinking about more any GDP growth whatsoever to add more gross ton miles to the consumer side of economy. It's just still a very, very, very busy rail network.

John Larkin - Stifel Nicolaus

Thank you. Had another question regarding the Intermodal numbers, which are very intriguing with the big volume drop year-over-year, but then the big increase in yield. Were both those moves a function of the large customer's decision to retrench from the trans-Pacific market?

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

Yes, I mean there is some cause and effect there, but that was part of it. The second part of it is revenue empties have been shrinking dramatically as we talked about for the last few quarters and then the westbound loads have improved because of exports, but it's what's coming off a relatively small base so it certainly didn't make up the revenue empties, but the revenue quality of a load versus the empty is significantly higher, so that all contributed to the mix.

John Larkin - Stifel Nicolaus

Okay. And a question for Carl, some of the competitors, particularly Brandex out in the west has talked a fair amount of that increased train link and the operating leverage that you get with that. We don't hear you talking about that quite so much; any thoughts on whether you have some leverage there, whether you are taking advantage of it, or whether there is any siding length constraints you have to deal with?

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

Well, we certainly think it's a big driver; it drives into service, expense and capacity all three. We back actually had over previous quarters talked about that a lot and it's shown significant improvement, we thought we have shown it so many quarters, we dropped it a quarter or two ago, we're probably up in total compound annual growth by 1% or 2% although I'm not positive about that number, but we'll expect to keep making an improvement.

John Larkin - Stifel Nicolaus

And could you give us a brief update on the status of the double track project in Chicago railway as well as where you stand in putting up the Intermodal yard would it be dock side I thinks it's in L.A.

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

Sure, I'll start and then Matt may want to go ahead. In terms of the double tracking, the Chicago L.A. route; that continues although as we've said a couple of times, our expansion capital is down for next year. We know we'll meet that double track, but we won't meet it quite as quickly, based on where we're volume wise. So we're finishing some of the projects that were under way, couple of others we probably won't do quite as quickly, but sometime over the next couple of years, two or three years we'll have it all completed. And of course, we do those based on where we need to bring the capacity on line first. In terms of the new dock facility that we're more continuing to move forward to get permit in.

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

We just had a... I think another favorable development in that, John where the local business chamber and everything are looking at how to get LA Long Beach growing again and one of the things that they've put in this commission and this report that they've set is to that's if our we called skid project out of the bill.

John Larkin - Stifel Nicolaus

Understood. You have talked a fair amount of how strong grain was, mostly export I guess. Are you also seeing a similar strength in phosphates and fertilizers into the grain growing regions?

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

Absolutely, particularly with the increased corn plantings.

John Larkin - Stifel Nicolaus

And where does that show up in your numbers?

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

It's in the Ag numbers

John Larkin - Stifel Nicolaus

Oh it is.

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

We captured all the fertilizers and the Ag numbers.

John Larkin - Stifel Nicolaus

And is that business roughly as profitable as the grain business itself?

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

Depends on what type of the grain business, some of it quite frankly is more profitable because of the risk, the issue that we have of hauling some of those materials and then there's as you know John, there is a kind of a plethora of different values that we get off of our grain business.

John Larkin - Stifel Nicolaus

I see. And finally I just wanted to thank you Matt for serving on the Surface Transportation Commission and putting all that time into what could be a very valuable plan if it were to be implemented and I guess that's the million dollar question, what do you think the chances are that some of those recommendations at least get implemented here over the next couple of years?

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

I don't know, I think we gave the Congress the blue print specifically on some restructuring of the DOT and restructuring of the programs, I mean there is a 110 federal programs out there and we narrowed it down to 10. And what we did from a rail standpoint, but I think is important is that we had talked about the need for regulatory policies, labor policies that are pro-rail growth. And so getting those things in front of people, I think are important and there are some very politically charged issues like gas tax increases that are going to be really hard for the members of Congress to pass. But it also I think helps for them to be able to point to an independent commission that pretty much across the board generally agreed that gas taxes need to go up to fund this infrastructure, and we gave them a lot reasons of why they need to do it. Whether they do it, probably certainly is going to be this year, but as next T-Bill is being drafted hopefully we will start to see some of those recommendations we put into that.

John Larkin - Stifel Nicolaus

Excellent, thank you for taking my questions

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

You bet John, thanks.

Operator

Our next question comes from the line of David Feinberg with Goldman Sachs; please go ahead.

David Feinberg - Goldman Sachs

Good morning,

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

Hi David.

David Feinberg - Goldman Sachs

Hi how are you?

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

Good.

David Feinberg - Goldman Sachs

I think you might answer some of these questions, but figure out taking on a slide [ph]. With regard to the $115 million reduction in expansionary CapEx in 08, if I look at the slide 32 in your presentation, the total dollar amount of expansionary CapEx is going to be the smallest amount that you've invested since 04. Just trying to reconcile some of your comments and answers to the earlier questions. Have we just simply reached a point where Burlington Northern has completed the bulk of its expansion and capital projects or is the reduction year-over-year more a factor of your outlook for volume outlook and maybe as a corollary there, just trying to get an idea which of the projects you are going to invest less in, in 08 and in 07?

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

Yes, I don't think you ever complete, I mean from our standpoint, this is a it or did [ph] thing and if you take a look out of ten year, you will us where we got down to as low as I think $50 million or $75 million of expansion capacity. So we know how to go really low in expansion capacity. This team has done that before, we know how to go really high, I think we have had a high of almost $800 million. So it's just the network is always going to flex up and down on two issues. One is what we see the sustainable growth that's coming on to the network and what the current capacity will allow us to do and then two, whether or not the returns will justify those investments.

In regard to the first one, quite frankly, we are very bullish long-term, all of these businesses will continue to grow, but quite frankly we've got the capacity now by better velocity as well as the investments we put in to be able to handle that growth. And point two is that we've always said, double-digit type returns, we will continue to invest in as long as we see the need for it. Right now, with the growth that we saw last year and what we are projecting this year, we will take a slightly less amount of expansion capacity that we're going to put in, but I think you also still have to realize that several $100 million is still lot of money to put on a network to expand the railroad and if you look at it historically, these are still significant investments that we're making.

So we're still very bullish around what we believe is our long-term growth in network through profitable investments. And as far as where we are putting them, it's kind of lot of the same old cast of characters where we look at our network and where we think the long-term safe investments are that is our core route, that is our Intermodal routes and that is the preponderance of the expansion capacities being put into the network.

David Feinberg - Goldman Sachs

Great. And then a follow-up question, you've made the comment earlier that, should we see a pick up in U.S. GDP growth in the second half of the year, we could see an outsize growth in terms of freight volumes in the U.S. Is the opposite true? Should the U.S. set into recession and we get negative GDP growth on the year-over-year basis, could we see another outsized leg-down in terms of freight volume growth in the U.S. or have we reached some sort of a bottom, any opinion?

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

No, I mean, it's... people are always asking us, are we in a recession as this thing getting worse? We're really not the guys to ask that. I mean we can tell you how the network is reflected by the volumes and right now, our network and when we look at each of our commodities, it doesn't represent a core recession. If you define a recession by being negative 4%, 5% type of negative growth. That is not what we seeing at all. But who knows what this credit crisis could eventually work to? Who knows what the restructuring the banking industry could be? Who knows what the subprime thing could turn into? So we're not saying that we're not headed towards a recession, we don't know that but right now our volumes don't represent that at all, but certainly if we started to see negative 4% or 5% type GDP growth, you would see fewer gross ton miles on a highway and fewer gross ton miles in the railroad industry.

David Feinberg - Goldman Sachs

That's on top of the volume decline that we saw in 07

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

Yes.

David Feinberg - Goldman Sachs

Thank you very much.

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

I think that's very logical that you would assume that.

David Feinberg - Goldman Sachs

Thank you.

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

But the good news is, for us we do believe we've got a nice balance in terms of portfolio that a lot of our businesses just won't go down, like our Coal business and our Ag business to some degree.

Operator

Our next question will come from the line of Walter Spracklin with RBC Capital Market. Please go ahead.

Walter Spracklin - RBC Capital Markets

Thanks very much. Good morning guys.

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

Good morning

Walter Spracklin - RBC Capital Markets

I just wanted to ask a question on labor relations going to 2008, couple of your... the other Canadian guys have had some hiccups with their labor negotiation. Can you talk to us a bit about any upcoming negotiations in 2008 and what are your thoughts going into those?

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

We are done; well, we've actually got two unions left. Assuming the UTU ratifies, we've got one smaller workgroup, but that's pretty much labor peace for us through 010 and then we will began this process again in 09. So we pretty much conclude the five year retroactive for three years past and then a year after we conclude, we usually start again. So, from our standpoint, everything is put to bed in 08 and 09.

Walter Spracklin - RBC Capital Markets

Okay. Just on the strategy in terms of your share buyback, you noted your 07 came in as a key. Give us little update on what you are... how you are looking at your share buyback, any big changes foreseen in that or in your dividend pay-off strategy.

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

No, I think right now I'd say for 08, it's probably more of the same and that is we're continually I guess measuring our capability based upon our cash flow in relation to debt and cash flow in relation to interest and last year we bought back 40 million shares, spent well over $1 billion, between $1.1 billion and $1.2 billion. And based upon the cash flow we see generating, I think that's probably pretty comparable. In dividend, we always discuss and evaluate with the Board mid-year, we have obviously that up to July meeting, we'll do the same. But I don't expect that we'll see any dramatic difference in what we've done over the past four or five years.

Walter Spracklin - RBC Capital Markets

Okay. Just two more questions here, first on the fuel surcharge, you've mentioned that participation rate is going up. Can you quantify, just give a sense of magnitude as to the level of participation you are at right now versus where you were on a comparable basis perhaps same time last year?

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

We're probably up four to five basis points over last year. We've got a slightly over 90% of our customers with some form of fuel surcharge, either a direct fuel surcharge program or RCAP fuel.

Walter Spracklin - RBC Capital Markets

Any thoughts on altering that in 2008, I know some people have been changing their fuel surcharge strategy a little bit, any thoughts on that?

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

Not at this time.

Walter Spracklin - RBC Capital Markets

Okay. And last question just I guess, you did touch on this, but did you go over the economic assumptions that are going into your 2008 or my sense is you're assuming sort of a soft landing, may be a pick-up in the back half of 2008. Is that a fair characterization of how you're seeing the economic growth outlook for 2008 on a macro level?

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

Yes I think its fair, I mean we don't... we're really not saying that it's going to be a soft landing or not, we're expecting more little stronger volumes in the second half because of the year-over-year comps get released here. We expect the good reads [ph] with forecast trans-Pacific trade to be in that 4% to 5% range, we are expecting again about 4% to 5% of coal growth, should have a better Ag year, when the housing market bottoms and when you start to see bottom on lumber and all those things, we are really not stating anything on that stuff.

Walter Spracklin - RBC Capital Markets

On the trans-Pacific trade, you mentioned 4% to 5%, you are down 15% this year obviously on that decision of the customer. So if we are taking out the customer in the... given the back half, you are seeing more of a general 4% to 5% run rate given all the long-term factors that we have in placed minus that customer, about a 4% to 5% growth in that line of business in the second half. Is that a fair assessment?

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

Yes, that's where it actually played out last year, the forecast were way off from the global prognosticators as far as with the trade numbers were, so lot to see what the trade numbers actually play out in. And also the mix in freight as well as Southern California continues to become an increasingly large market, a lot of freight stays in southern California, the local consumption market as well so we have to watch those patterns also.

Walter Spracklin - RBC Capital Markets

Okay, thanks very much for the call guys.

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

Thank you.

Operator

Our next call comes from the line of Gary Chase with the Lehman Brothers. Please go ahead.

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

Hi Gary.

Gary Chase - Lehman Brothers

Good morning guys. I apologize if I missed this a few, if you've touched on it, just had to jump on and off a little bit here. But I was interested in something that you said Matt about the RCAP escalators, kind of bringing you a bit more current in terms of fuel recovery in the coal business. So two questions on that; one, are you anywhere close to where you would be under a more typical fuel surcharge; and second, for the 15% or 20% of the business that I think it was John, you quantified that as re-pricing opportunity in coal, does all of that 15% to 20% have RCAP escalation in it or does some of it have nothing at all?

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

The RCAP fuel side does not properly compensate a... specifically, us being a western railroad. There is a big huge field, intensity factor of our link of haul greater than other railroads and that's been our position, that RCAP doesn't properly... it will never properly capture that. So that's really why we have looked at going to more of a conventional fuel surcharge.

So right now, we've got two types of surcharges, if you will, or escalators if you will. We have the RCAP, which is going to go up significantly quarter-over-quarter, probably record RCAP of all times that I am aware of, like 11%. And it's just simply because fuel is such, it has gone up so much and even given that, it doesn't properly compensate us with the longer length of haul. So we have that RCAP device, and then we have the other device, which is the more conventional fuel surcharge where we take RCAP and we take the fuel component out and that's where we have applied our fuel surcharges. And every year as we've said repeatedly, we get access to 10% to 12%, 15% of our coal contracts. We are going to more of a conventional fuel surcharge, which we think is appropriate and fair for our customers and as you've seen with the STABILIZATION, their mandate has been to go to a mileage base fuel surcharge that really puts fuel based on weight and miles, which again we said pretty clear that is the most appropriate type of fuel surcharge out there.

Gary Chase - Lehman Brothers

So fuel is catching up, fuel is helping RCAP catch up, but there is still a pretty wide gap between that and where our conventional mechanism would be?.

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

Absolutely, you got it right.

Gary Chase - Lehman Brothers

And then on that15% to 20%; is all of that covered by RCAP?

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

Yes, almost up, virtually all of it.

Gary Chase - Lehman Brothers

Okay guys, appreciate it.

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

Thanks.

Operator

Our final question will come from the line of Scott Flower with Golden Spike Research [ph]. Please go ahead.

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

Good morning Scott.

Unidentified Analyst

Good morning. Just a few questions; I know that you talked about mixing negative and I guess what I am just trying to understand about that is, is that just a function of the mathematics of which units grew because if I look unit-by-unit, it would seem like ex-lumber, most of the individual units will have mix positives. So I guess I am trying to square is that just a mathematics of where the overall growth was versus if I look unit by unit, it almost seems like you had mix positives in most of the different sub-segments?

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

Yes, it's really is the math Scott.

Unidentified Analyst

Okay, because I would assume with PNW exports on grain, with the international function on what's going on in the Intermodal, that should help those individual segments. I guess the other question I had is, when I look at your legacy contract, and I knew you said its mainly in coal, what proportion of legacy rolls over into '08, I know it's predominantly coal, is that 5% of the total or is that less than that or more?

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

No, it's somewhere in that 5% to 10%.range.

Unidentified Analyst

Okay. And then other question I had and I think this is for Tom, is on the internal compensation or is this just the normal bonus compensation for fourth quarter, you didn't make plans, except your net obviously that just self adjusting mechanism, was there any true-up the prior quarters or was that just a normal accrual relative to what you did versus what your internal bogies were for fourth quarter, or is there a true-up versus the first three quarters in the year?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

No, we were lower in all of the quarters compared to '06, so there was no true-up. And it is as Matt pointed out earlier, it is two components, it is both the incentive comp for our employees as well as the profit sharing because we're all measured off of the same goals and that represents probably about a quarter of our scheduled work force.

Unidentified Analyst

Okay, but that's just related to the fourth quarter?

Thomas N. Hund - Executive Vice President and Chief Financial Officer

Absolutely, fourth quarter was just fourth quarter.

Unidentified Analyst

And then last one maybe for Carl is, obviously you mentioned sort of the four or five different key hard areas you're focusing on. Can you give me a sense which of those 4 or 5 initiatives have perhaps the most leverage or are they all sort of bits and pieces that cumulatively add about the same amount or have the same potential when I think about those 4 or 5 different things you're focused on?

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

Well, generally I think it is the power of them being additive than more than its one or two, but if we would have pick one or two, we're sure intend upon terminal processing and driving what we call in BNSF the best way to drive consistency across the terminals that's important and then in our maintenance areas, our ongoing maintenance reliability and planning.

Unidentified Analyst

Okay, very good, thank you all.

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

Thank you. All right Sandy, have we done it?

Operator

Yes.

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

All right, thanks everybody for your interest. We'll talk to you next quarter. Have a good day.

Operator

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

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