Operator: Greetings and welcome to the Union Pacific's Second Quarter 2013 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded, and the slides for today's presentation are available on Union Pacific's website.
It is now my pleasure to introduce your host, Mr. Jack Koraleski, CEO for Union Pacific. Thank you, Mr. Koraleski, you may begin.
John J. Koraleski - President and CEO: Thanks Robin, good morning, everybody. Welcome to Union Pacific's second quarter earnings conference call. With me here in Omaha are Rob Knight, our Chief Financial Officer; Eric Butler, our Executive Vice President of Marketing and Sales; and Lance Fritz, our Executive Vice President of Operations.
This morning we are pleased to announce that Union Pacific achieved an all-time record quarter generating an earnings milestone of $2.37 per share, an increase of 13% compared to the second quarter of 2012. We managed our network efficiently and continued to show the agility of our strong and diverse franchise. When combined with solid core pricing gains, we've more than offset the slight shortfall in volumes, generate a new best ever quarterly operating ratio of 65.7%, translates into value that we are creating for our customers and increased financial returns for our shareholders. So with that let's get started, I'll turn it over to Eric.
Eric L. Butler - EVP, Marketing and Sales: Thanks, Jack and good morning. Let's start with how we are creating value for our customers the cornerstone of our strategy. So I'll start with the industry's best franchise which provides customer's access to diverse and growing markets. Through targeted investments we continue to enhance this franchise so that we can deliver the best service that support future growth.
Our passion for providing excellent service has allowed us to introduce innovative products that not only run business, but also secure re-investable returns. The capstone of our value proposition is our relationship with our customers, a key component that we worked hard to develop and maintain.
Today, our value proposition is stronger than ever as reflected by our customer satisfaction scores, which came in at 93 for the second quarter. We appreciate this recognition from our customers and continue to focus on providing excellent services strengthening our value offering.
In the second quarter, volume was down about 1% compared to last year as strong growth in chemicals and solid gains in automotive were offset by declines in intermodal and ag. The drop related decline in ag continues to have a significant impact on overall volumes. Setting ag aside, the other five groups were up about 1% in total.
Core price improved 4% with all six businesses posting gains. So, pricing gains along with some positive mix were the main drivers in the 5% improvement in average revenue per car. With price driven average revenue per car gains outpacing the volume declines, freight revenue grew 5% to more than $5.1 billion.
Let's take a closer look at each of the six groups, starting with two that saw a decline. Ag products revenue declined 8% with second quarter volume down 10% and a 2% improvement in average revenue per car. Last summer's drought continued to impact grain car loadings with second quarter volumes down 22% from last year. Domestic feed grain shipments declined a tight U.S. corn supply especially in UP served territories led to reductions in livestock feedings and increased sourcing from local crops that are less likely to move by rail.
Export feed grain shipments also declined with limited U.S. supply and improved world production. Grain product shipments were down 1% as more DDGs were fed locally, driving a 17% decline in DDGs volume. Ethanol shipments provided some good news, growing 3% as production picked up from replenished low ethanol inventory.
Food and refrigerated shipments also declined 3% as lower U.S. sugar prices driven by surplus conditions reduced sugar imports from Mexico and restrictions in Russia and China limited USB import/export. Intermodal revenue was down 1% as the price-driven 2% improvement in average revenue per unit partially offset a 3% decline in volume. Lower volume was due to the declines in international intermodal where soft West Coast imports reduced shipments by 8% following strong first quarter gains. With modest retail sales growth, retailers remained cautious about overstocking inventory levels. Volumes fared better for domestic intermodals where continued success converting highway business to rail in both dry and refrigerated containers drove volume up 3%.
Automotive volume grew 4%, which combined with an 8% increase in average revenue per car to drive revenue up 12%. Driven by replacement demand, favorable financing and an improving overall economy, vehicle sales continued to gain momentum with the seasonality adjusted annual sales rate reach 15.9 million in June, the highest level since late 2007.
New models offering more features and improved fuel efficiency are compelling consumers to replace aging vehicles, in addition upticks in housing and construction activity has increased demand for light trucks. While overall auto sales continued to reflect strong growth, our finished vehicle shipments saw more modest inventory, reflecting a 2% gain as select OEMs faced downtime to deal with model changes and new product launches.
Parts volume increased 5%; while pricing gains in the previously mentioned Pacer network logistics management arrangement increased average revenue per car.
Chemicals volumes increased 10% which combined with a 2% improvement in revenue average revenue per car to produce a 12% increase in revenue. Crude oil volume was up 3% from the previous quarter and increased nearly 40% when compared to the second quarter of last year. Growth was driven primarily by increased shipments from Bakken, Western Oklahoma, and West Texas shale plays and UP served terminus in St. James, Louisiana and the Texas Gulf Coast and Arkansas. Our petroleum products in LPG gas business was up 10%, driven by growth in residual fuel oil and asphalt shipments. Strong international demand for potash led to a 7% increase in fertilizer shipments while most of other segments also posted gains reflecting the continued strength of our chemical business.
Turning now to coal, you can see from the chart of weekly carloadings that the second quarter volumes began to stabilize and finished the quarter a little bit better than flat compared to last year. Core pricing gains led to a 12% improvement in average revenue per car and produced a 12% increase in revenue.
Tonnage from the Southern Powder River Basin increased 1% as declining utility stockpiles and higher natural gas prices improved the demand for coal. Powder River Basin stockpiles are estimated to have declined 21% from their peak in April 2012, (swinging) from 24 days above normal at that time to about 1 day below normal this May. New business also provided a boost, but these gains were offset by utility outages and the previously mentioned loss of a legacy customer contract at the beginning of the year. Soft domestic demand, a weak international market for Western U.S. coal and mine production issues lifted limited shipments of Colorado, Utah coal, with tonnage down 11%.
Industrial products revenue increased 7%, even as volume remained flat, driven by 6% improvement in average revenue per car. Non-metallic minerals volume was up 18% as continued growth in shale-related drilling increased frac shipments by 24%. Growth in housing starts and residential improvements increased the demand for lumber, with shipments up 11%. Although, the housing market continued to strengthen, lumber's pace of growth eased slightly in the second quarter as falling lumber prices, excess inventory and wet weather slowed lumber shipments. On the downside, lower steel production and soft global demand impacted scrap steel, with volume down 17%. Rock shipments declined 5% as local sourcing impacted some of our short haul business into the Eagle Ford shale play. We also saw a steep decline in military shipments, with reduced deployments in training locations to facilities on our network.
That wraps up the second quarter, so let's take a look ahead at what we see for the second half of 2013. Our current outlook is for the economy to show some improvement from the sluggishness we've seen in the second quarter. Although we'll continue to face challenges in some markets, our diverse franchise still provides opportunities to grow in others. The diminished 2012 corn crop will continue to impact ag products in the third quarter, but an improving export wheat market should offer some relief. The pace of decline for Ag products should ease, with third quarter volumes expected to be down in the lower single digit range. We hope to see a return to trend line yields when the new corn crop comes in later in the year, which should provide some opportunities.
Global Insight has raised their full-year light vehicle sales estimate to 15.4 million vehicles from 15.0 million at the beginning of the year, which should be good news for our automotive business. Crude oil should continue to drive chemicals growth, but the growth rate will continue to ease against 2012's larger base. Most other chemical markets are expected to remain solid.
Moving to coal, the loss of a customer contract at the beginning of the year will continue to impact volumes. While we expect coal volumes to increase sequentially in the third quarter, year-over-year volume curve for the quarter will depend upon weather conditions. Industrial products should also continue to benefit from shale related growth, with increased drilling activity and a ramp up in pipeline projects after a slow start to the year. The housing market continues to recover, which is expected to drive demand for lumber. We expect continued success in converting highway business for Domestic Intermodal, and International Intermodal should pick up as the slowly growing economy is expected to produce a positive, but somewhat muted peak season.
For the remainder of the year, our strong value proposition and diverse franchise will continue to support business development opportunities across our broad portfolio of business. Assuming an improving economy and a normal summer weather pattern, we expect to finish the full year with a slight volume increase, which combined with pricing gains, will generate profitable revenue growth.
With that, I'll turn it over to Lance.
Lance M. Fritz - EVP,Operations: Thanks, Eric, and good morning. I'll start with our safety performance for the first half of the year. Our year-to-date reportable personal injury rate increased 5% from 2012. However, the number of severe injuries declined to a record low, which reflects our work to reduce risk and the team's deep personal commitment to safety, something we call the courage to care.
Rail equipment incidents or derailments improved 1% versus 2012. Our continued investments to harden our infrastructure as well as leverage advanced defect detection technology, have driven a reduction in track and equipment induced derailments.
Moving to public safety, our grade-crossing incident rate improved 3% versus 2012, reflecting our focus on improving or closing high-risk crossings and reinforcing public awareness. Our second quarter rate of 1.85% was a second quarter best and represented a significant improvement over the first quarter performance. Incident rates improved in each region of our network, including the South, where there is a higher grade-crossing density than our overall network.
Moving on to network performance, in the second quarter the network remained fluid, but it does have room for improvement. Overall, velocity was down 3% and terminal dwell was up 4% in the quarter, both adversely impacted by weather interruptions and heat induced slow orders in the South Western portion of the network. Increased track renewal programs and high volume corridors also played a role.
Weather challenges included flooding that impacted major gateways in Chicago, St. Louis and Eagle Pass, Texas. As a result, we saw a 25% increase in the number of days with major interruptions versus the second quarter of last year.
Infrastructure investments that enhanced our agility and resiliency enabled us to rapidly recover after each incident reducing the impact from these events. Overall, our network remains solid and well-positioned to handle volume growth. We continued to provide outstanding local service to our customers with the best ever 96% industry Spot & Pull, which measures the delivery or pulling of a car to or from a customer.
Our service delivery index is a measure of how well we are meeting overall customer commitments, declined modestly compared to the second quarter of 2012. Half of the decline is going to be attributed to tighter service commitments to our customers and the effect of traffic mix changes. Despite these challenges, we achieved sequential improvement in both service delivery and terminal dwell compared to the first quarter. Solid network fundamentals position us to operate at improved service levels going forward. We are continuing to increase capacity across our network, most notably in the South, where volumes have rebounded to prerecession levels.
Moving on network productivity, slow order miles declined almost 30% to a best ever second quarter level. We've made substantial advancements in the south with process improvements that allow us to maintaining the railroad, while providing value-added service levels. As a result, our network is in excellent shape, reflecting the investment in replacement capital that has hardened our infrastructure and reduced service failures. We continue to leverage existing resources in growth markets, as well and realizing efficiencies in more challenging segments.
During the second quarter, we turned a 4% growth in automotive volumes into an average train size increase of 2%, running an all-time quarterly record of 65 cars per train during the quarter. Despite the 22% decline in grain volumes, we were able to run near record second quarter grain train length, with manifest and coal train lengths falling just short of quarterly records.
Intermodal train sizes reflect the challenge of an 8% dip in international volume. We continue to find ways to utilize assets more effectively through process improvement and targeted capital investments. A good example of this is the Fort Worth terminal, which is a major network yards that supports Texas oil and gas fields, Mexico, the automotive networks and construction markets.
The UP Way uses process improvement tools like value stream mapping and the A3 problem solving process to find and apply counter measures for process bottlenecks and service failures. More importantly, it engages those doing the work and generating these counter measures. Collecting and focusing the power of the teams. Through our UP Way initiative, we are handling substantially more cars through our key network yard in Fort Worth at better service level.
Our capital investment strategy also plays a vital role. Our targeted 2013 capital spend is still around the $3.6 billion mark. About $2 billion of that is replacement capital with most of that to renew our track infrastructure. We are on target for the year as more than half of that program work is now complete.
Spending for service growth and productivity will total around $1 billion. Capacity, commercial facilities and equipment are the primary drivers. Spending on positive train control will total $450 million for the year.
Major projects include work on the Santa Teresa, New Mexico rail facility, which is slated to open in early 2014. This year's progress on Sunset Corridor includes about 30 miles of double track. Additionally, our capacity expansion plans in the South are increasing more than threefold from spending levels in 2011, helping support the efficient movement of growing volumes in that region. We are adding sidings, expanding terminals, double tracking some routes, and upgrading signals. We're also purchasing 100 locomotives, 900 freight cars, as well as some domestic containers to replace units currently on lease or being retired. It is important to note that all of these projects have a positive safety impact, whether it's replacement or service and growth capital. The growth capital must meet aggressive returns thresholds or we just will not pursue the project.
So to wrap it up, we remain optimistic on our operating outlook for the second half of the year and our ability to realize network improvement on various fronts. We remain steadfast in our commitment to operate a safer and more efficient railroad for the benefit of our employees, customers, the public and shareholders. We remain agile managing network resources in response to dynamic market shifts and unexpected events. The network is strong and fluid, capable of handling volume growth at safe, efficient and reliable service levels. Our continuous improvement efforts, and particularly, the UP Way will continue to generate process improvements that add value for all of our stakeholders. To support our growth initiatives, we will continue to make smart capital investments that generate attractive returns, all of which will continue to enhance our overall value proposition.
With that I'll turn it over to Rob.
Robert M. Knight, Jr. - EVP and CFO: Thanks, Lance, and good morning. Let's start with a quick recap of our second quarter results. Operating revenue grew 5% to an all-time quarterly record of nearly $5.5 billion, driven mainly by solid core pricing gains.
Operating expense totaled $3.6 billion, increasing 3%. Operating income grew 9% to $1.9 billion, also hitting a best ever quarterly mark. Below the line, other income totaled $23 million, up $2 million compared to 2012. For the full year, we're still projecting other income to be in the $100 million to $120 million range, barring any unusual adjustments.
Interest expense of $133 million was $2 million lower than last year, while income tax expense increased to $662 million, driven by higher pretax earnings. Net income grew 10% versus 2012, while the outstanding share balance declined 2% as a result of our continued share repurchase activity. These results combined to produce a best-ever quarterly earnings record of $2.37 per share, up 13% versus 2012.
Turning to our top line, freight revenue grew 5% to more than $5.1 billion. Solid core pricing gains of 4% and positive mix of about 2 points, driven by a decline in lower average revenue per car Intermodal shipments, more than offset the slight decline in volume levels. In addition, fuel surcharge revenue was down from last year due to a lower average diesel fuel price and lower volumes.
Moving on to the expense side, Slide 22 provides a summary of our compensation and benefits expense, which was up 3% compared to 2012. Inflationary pressures of about 2.5%, combined with shifts in traffic mix to more manifest business, which requires additional employees, drove the quarterly increase. Lower volume costs and productivity gains partially offset these increases.
Workforce levels increased 2% in the quarter. About half of the increase was driven by capital projects including positive train control activity. The other half was driven by a shift in traffic mix that I just discussed.
Turning to the next slide, fuel expense totaled $863 million decreasing $19 million versus 2012. A 3% decline in the average diesel fuel price drove the reduction in the cost. Gross ton miles were essentially flat compared to last year. Conversely, our consumption rate increased 2% compared to 2012.
Moving on to other expense categories; purchase, services and materials expense increased 8% to $585 million due to higher locomotive and freight car contract repair expenses and joint facility maintenance expenses. As we discussed in April, we continue to incur logistics management fees associated with the new Pacer agreement, which are recouped in our automotive freight revenue line.
Depreciation expense increased 1% to $438 million. The impact of increased capital spending in recent years was partially offset by a new equipment rate study that we discussed with you earlier this year. Looking at the full year 2013, we now expect depreciation expense to be up in the 1% to 2% range versus 2012 due to the timing of asset purchases and project work completion.
Slide 25 summarizes the remaining two expense categories. Equipment and other rents expense totaled $302 million, up 1% compared to 2012. Increased container expenses associated with the new Pacer contract and growth in automotive shipments drove higher freight car rental expense. Lower freight car and locomotive lease expense partially offset these increases. Other expenses came in at $219 million, up $29 million versus last year.
Despite the long-term improvement trend in our safety performance, personal injury expense increased compared to a tough comp last year. Our recent actuarial study resulted in a smaller reduction to our estimate for prior year activity compared with the second quarter of last year. In addition, higher operating taxes and freight and property damage costs also drove expenses up compared to 2012. For the second half of this year, we still expect the other expense line to average around $225 million a quarter, barring any unusual items.
Turning to our operating ratio performance, we achieved an all-time best operating ratio of 65.7% this quarter, improving 1.3 points compared to last year. Our performance highlights the positive impact of solid core pricing gains and network efficiencies despite the slight shortfall in volumes. Looking ahead, we remain committed to achieving a full year sub-65 operating ratio by 2017.
Union Pacific's record first half earnings drove strong cash from operations of more than $3.2 billion, up 16% compared to 2012. Free cash flow of $833 million reflects the growing profitability of the franchise, more than offsetting the 12% increase in cash dividend payments versus 2012.
Our balance sheet remains strong, supporting our investment-grade credit rating. At quarter end, our adjusted debt-to-cap ratio was roughly 40%. Opportunistic share repurchases continue to play an important role in our balanced approach to cash allocation.
In the second quarter, we bought back nearly 3.1 million shares, totaling $463 million. Since 2007, we've repurchased over 97 million shares at an average price of around $82 per share. Looking ahead, we have about 9 million shares remaining under our current authorization, which expires March 31, 2014. So that's a recap of our second quarter results.
Looking at the remainder of the year, the economy will be a key driving factor. Assuming an improving economy and summer weather conditions that will drive coal demand and fall crop harvest yields, we are projecting positive volume growth for the second half of the year, which should bring full year volumes to the positive side of the ledger.
In the third quarter, we'll continue to see a year-over-year decline in our Ag volumes, however, not at the magnitude that we saw in the second quarter. As for our coal shipments, summer weather will be the determining factor. In addition, we'll have to see how is consumer sentiment and the economy impact the intermodal peak season this year. However, we do think there are continued growth opportunities in other market sectors that have the potential to offset these uncertainties.
Combined with continued real core pricing gains and our ability to leverage our diverse franchise, we expect to achieve yet another record financial year with best ever marks in earnings and operation ratio. We are well positioned through the first half of this year, regardless of the hand that the economy deals us, we'll remain focused on our ability to generate improving returns required to strengthen and enhance our network, create value for our customers, and drive increased returns for our shareholders.
With that, I'll turn it back over to jack.
John J. Koraleski - President and CEO: Thanks, Rob. As we move into the second half of the year, the economic outlook remains uncertain, but from our perspective the underlying economy in the second quarter seems somewhat weaker than it did in the first quarter. We are hopeful that we'll see some economic improvement in the months ahead. We are well-positioned with our diverse franchise, our strong value proposition and our excellent service offerings while remaining agile in today's changing environment. We'll continue focusing on re-investable pricing, attracting new profitable growth opportunities and running a safe, efficient, and reliable network that generates greater value for both our customers and our shareholders going forward.
With that, we'll open up the phones for your questions.
Operator: Chris Wetherbee, Citigroup.
Chris Wetherbee - Citigroup: Maybe first a question on the coal business. You saw a nice sequential step-up in the coal yields there. I guess I am just trying to think about how we should be thinking about the mix of what was previously priced legacy business and maybe what is kind of current run rate business as we think out into the back half of the year. I guess I am just trying to get a sense of maybe what the mix factors could be when we look at the coal business in the second half of 2013.
John J. Koraleski - President and CEO: Chris, if you look at it, I think we had $350 million of legacy up for renewal this year and we retained about 80% of that. Majority of that was coal business. There is really nothing significantly changing as we go forward for the balance of the year. The mix impact that you are going to see is really going to be dependent on the coal burn in the various customer regions and zones. So, there is really not much more clarification. Eric, do you have anything to add to that?
Eric L. Butler - EVP, Marketing and Sales: No.
Chris Wetherbee - Citigroup: I guess, I am just trying to maybe get a sense, you lost a contract earlier in the year which I think you had mentioned was about 5% of the business. So, it would seem that the underlying business is obviously doing better than kind of the flattish volumes you are seeing there. But that’s helpful. Maybe switching gears with the follow-up. Just on the back of crude-by-rail, when you think about the tightening differentials on WTI versus Brent, have you seen a deceleration in the pace of activity at St. James, for instance? Just trying to get a sense of how we should be thinking about the sequential pace of crude-by-rail in the back half.
Lance M. Fritz - EVP,Operations: We really haven't seen any impact at St. James. We have had seen some minor impact in our Texas business, where there is a lot of pipelines. Eric, you want to add?
Eric L. Butler - EVP, Marketing and Sales: The intrastate Texas short-haul business, we always take opportunistic opportunities to move some of that, which is pretty directly competitive to pipeline, given the fact that it is pretty short-haul stuff. So we've seen some decline in that but really nominal for our base book of long-haul Bakken the St. James business, we feel pretty good about the continued opportunities with that.
Operator: Scott Group, Wolfe Research.
Scott Group - Wolfe Research: I wanted to first just follow-up on coal. So if I remember earlier in the year, you guys were guiding to slight declines in coal volumes for the full year, and I guess the implication was positive volumes in the back half of the year. It seems like you have got maybe less visibility to coal now. I just want to understand that are you no longer confident that you're going to have positive coal in the full second half of the year?
Lance M. Fritz - EVP,Operations: Scott, we haven't changed our guidance, where we said that for the full year the we still think coal is going to be slightly down, given all the factors and given the fact that it was down 19% in the first quarter. So that does imply – with the flat performance in the second quarter that does imply strengthening in the back half. Where we're saying there is lack of clarify, if you will, is as always weather will be a huge factor in how the summer burn plays out in our coal business. As Eric pointed out, at this point in time, inventories are about two days lower than normal. So we're well positioned if the weather does not cooperate.
Scott Group - Wolfe Research: We're getting killed in New York, how is the weather cooperating in New York territories right now?
Lance M. Fritz - EVP,Operations: It's going to be 97 degrees in Omaha today, so we're doing high fives, but so far at least for the summer it's been okay, with actually a cooler spring than what we had hoped for, but the summer has heated up nicely and we're hoping that that's going to stay through the balance of the year of the season.
Eric L. Butler - EVP, Marketing and Sales: (We heard) that the Energy Department has put out estimates that suggest that electrical generation demand will be down 4% in the second half of the year. They probably don't have any better crystal ball than we do in terms of weather impact, but that is the data point this afternoon.
Scott Group - Wolfe Research: Just second question, why is international intermodal so weak, is there share losses to be in and do you think it's just the West Coast ports losing any share, they just seem surprisingly weak and want to get an explanation for it and how you think that plays out in terms of peak season?
Robert M. Knight, Jr. - EVP and CFO: Part of that maybe there were surprisingly strong in the first quarter, but Eric you can clarify that?
Eric L. Butler - EVP, Marketing and Sales: Yes, our first quarter was strong as you recall. There is always significant competition between all of the ports up and down, the West Coast and between ourselves and our competitors, but there is no significant share swing that has occurred. The real fundamental issue is retail indicators in this country, retail sales have really been mixed and you could argue even in the second quarter, they look like they have softened a bit. Supply chain manufacturers and retailers are continuing to send out the supply chain and trying to squeeze out inventory. So you have actually seen lower volumes coming into all of the West Coast ports from Asia. Certainly, what's going on in China might also have an impact to that. Certainly, near-sourcing to Mexico might have an impact to that, but you have seen lower volumes into all of the West Coast ports in the second quarter.
Scott Group - Wolfe Research: Why do you have improved international peak as a positive in the second half?
Eric L. Butler - EVP, Marketing and Sales: If you look at -- again, what we've said is the economy is what our outlook is dependent upon. If you look at inventory, if you look at some of the sentiment, it does suggest that later in the third quarter, the fourth quarter, there should be decent consumer sentiment for a strong retail season. If that happens, you will need to move the business because there are not a lot of inventories out there, so that would suggest a pick-up from where we are today.
Operator: Tom Wadewitz, JPMorgan.
Thomas Wadewitz - JPMorgan: I wanted to ask you about the kind of -- look on coal beyond second half of this year and the weather comments, but if you look into 2014 and 2015, have you seen any kind of, I guess, new indication from utilities that there are more coal plants being scheduled for shutdown, or is that pretty much status quo? When you look at that, would you say, hey, there might be some impact in 2014 to demand from coal plant shutdowns, do you think that's not going to be much of an effect?
John J. Koraleski - President and CEO: Eric?
Eric L. Butler - EVP, Marketing and Sales: As we discussed previously, coal shutdown plants in any amount that you might see, really is not the factor because there is more capacity than demand and you might hear about shutdowns that just kind of match capacity and demand. The key issue is what market share coal has. Coal is hanging in there pretty solidly at the 38%, 39% market share of total electrical generation. We see nothing on the horizon that's going to substantially change it. Certainly, there could be some environmental regulatory thing that could change that, but right now from a business economic standpoint; we've seen nothing on the horizon that's going to change that.
Thomas Wadewitz - JPMorgan: Then one on crude by rail, you commented on, I guess, the near-term trend. It sounds like there's somewhat negative impact on the short haul business, but really not in St. James. What about customer investment activity and the discussions that you're having that would kind of indicate how new terminals will be opened up looking out the next year or two. Is there a change in discussions? Are customers kind of slowing things down at all? Or is it pretty much the same as what you saw before when crude spreads were wider?
Robert M. Knight, Jr. - EVP and CFO: So actually customer investment in destination terminals is expanding both – in St. James there's a project well underway to expand that capacity. But more importantly and we've talked about this in the past, if you look at what's going on in California there is significant activity in terms of expansion of destination in terminals in California. We've mentioned before California is going to have a significant short haul. Their local crude production is declining. Alaska's slope is declining and so they are looking to source from Canada, from the Bakken and also from Niobrara and also Permian. So they need destination terminals in California and there is a significant activity, significant investment going on. Some has been public, some is not.
John J. Koraleski - President and CEO: We have seen no diminishing in the enthusiasm for customer investment in the oil business
Operator: Will Greene, Morgan Stanley.
William Greene - Morgan Stanley: In spite of a relatively modest revenue growth rate, the OR this quarter was very impressive, I think, by any measure and if we look at kind of how things change sequentially, typically your third quarter is the best, now I know you didn't give guidance, we are not sort of looking for that, but if you think about kind of anything in the third quarter or on a sequential basis, that means that we need to keep in mind something that's going to cause seasonality be off. Is there anything that you look at in this upcoming third quarter or even relative to last year, that's important for us to bear in mind, because this was pretty impressive and suggest that the long-term guidance will be achieved early?
John J. Koraleski - President and CEO: Bill, we don't see anything in the third quarter that we would consider to be unusual. There's always in the rail business unforeseens that could happen but at this point in time, we really don't have anything substantive. Rob or Lance?
Lance M. Fritz - EVP,Operations: Bill, I would just say, that one thing to keep in mind is always the factor in our business is mix, obviously can have a factor and so can fuel prices. I mean the fuel price is up for down, that can obviously have an impact. No, there is nothing directionally that's going change our commitment to continue to make progress on our operating ratio commitments.
William Greene - Morgan Stanley: Now, if you think about these long-term OR goals that you have, the ROIC has gotten to pretty good levels, certainly relative to history. How do you think about the implications over time of being above the cost of capital? Is that – do we have to start thinking about regulatory risks yet or is this – are we not really there?
John J. Koraleski - President and CEO: (indiscernible) as you've heard of say all along, I mean we are proud of the fact that we've improved our returns we are going to continue to reinvest in the business which is how we are able to reinvest this much capital as we do. As you have heard me say many times, if you look at our calculation of our returns on a replacement basis, our returns are around, call it, 7%-ish. So clearly, room for us to continue to improve that on actual replacement cost calculation. So, we're going – we are not going to change our behavior, we'll continue to run a safe, efficient network and price to value where we had add value to our customers and continue to move forward in our returns so that we can continue to make these capital investments that we'd like to make.
John J. Koraleski - President and CEO: Yeah, Bill, every chance I get in Washington DC, my message is very, very clear, that while we are earnings good financial returns, we are investing record amount of capital. We are providing great value and service for our customers and on a replacement cost basis, we're still not in the ballpark of where we need to be and I think that message has been well received, particularly given that customers are relatively satisfied with our service offerings.
Operator: Justin Yagerman, Deutsche Bank.
Justin Yagerman - Deutsche Bank: I was curious on coal yields here when I looked at things on an RPU basis. I mean we show volumes up nicely this quarter versus what we've seen at least last few quarters, and RPU declined sequentially. I am just trying to get to an idea as we look out to the back half and expect improvement from a volume standpoint year-over-year. How much of the prior legacy flow through should influence RPU. Would I be smart to expect stable, flat or down and obviously, I am assuming that we get decent burn going on this summer and that volumes do increase on a year-over-year basis?
Robert M. Knight, Jr. - EVP and CFO: Justin, the simple answer to your question is, it's difficult to give guidance on what you're asking in terms of the average revenue per car because mix plays such a key factor in that. But you are right, sequentially the average revenue per car did come down and it's driven primarily by the mix effect that Eric talked about, where volumes, as an example, were off 11% and our Colorado/Utah business, for example, while TRB was up in the quarter. So that's an example of mix effect. In terms of the pricing underlying what's happening in the coal business, there is no directional change. We've renewed those legacy contracts that Jack talk about and that should flow through for the balance of the year. So there is no change in that element of the average revenue per car, but the mix effect and the volumes associated with those repriced contracts will clearly play a role as we move forward.
Justin Yagerman - Deutsche Bank: Maybe a little bit on the longer-term view as we look out to the petrochemical projects that are coming online in your Southern corridor. Curious how we should be thinking about the timing? I know there is at least one cracker in 2014 and most of the rest of the stuff is beyond '14, but what's the timing of that project and how meaningful would you expect loads to start coming on in 2014 from that?
Eric L. Butler - EVP, Marketing and Sales: As you are talking about the expansion of the chemical production capacity due to low natural gas prices, I think there are roughly eight announced plant expansions. Most of those have turnover to operation base, I think in 2016 or beyond. So we are working with them now in terms of developing transportation alternatives, working with many of those customers and trying – and helping them shift their inbound construction materials to build the facility, but I think most of those will be late '15, early '16 or later.
Justin Yagerman - Deutsche Bank: I think there was one the (Groupo Mossi) project that was – that had an estimated completion in 2014. So I was curious as to what kind of production you would expect there to see and I noticed one of you guys have called out before in your presentations.
Eric L. Butler - EVP, Marketing and Sales: Well, we don't – as you know we don't list production from individual plants and individual customers. We do have a very strong chemical franchise with a lot of great value and we believe that there is upside. I think what we might have called out in the past about the (Groupo Mossi) facility was the 2016 start, I think that's what we called out. But we don't list individual opportunities and individual plants, but we are excited about all of the upside.
Operator: Ken Hoexter, Bank of America.
Ken Hoexter - Bank of America: You talked earlier about International Intermodal. If I can switch to Domestic Intermodal, you are looking at – I guess your volume was up about 3%. Would you anticipate that to grow faster on that? You've talked about, I think it was what, $10 million addressable loads plus I think another two or three for Mexico. Do you expect the conversion rate to pick up or is the 3% kind of your targeted run rate?
Eric L. Butler - EVP, Marketing and Sales: So as we look at Domestic Intermodal, it's a rich targeting area. I mean if we have said publicly that there is probably $9 million, $10 million loads that can be converted from truck to rail, we believe the strongest North-South Mexico franchise. We have six border points, truck business to and from U.S. and Mexico is growing rapidly this year. So we think there is a rich target area. We have a number of strategies and initiatives that we have underway with our partners in the intermodal industry to convert more truck to rail. We think there is lots of upside. Converting, there are a lot of issues and a lot of things that need to be done to do that effective conversion. I'm not sure I will give a roadmap in terms of what the number will be at what (period of time), but we continue to believe there is significant upside in the domestic intermodal market.
John J. Koraleski - President and CEO: I'm pretty excited, Ken, about the opportunity that we'll have in 2014 with the opening of our new facility in Santa Teresa to be able to take -- in addition to that 10 million truckloads, there is another three between the U.S. and Mexico and that facility is going to really -- we're going to really focus on that and target that. So we're looking forward to having that facility up and running here in 2014.
Eric L. Butler - EVP, Marketing and Sales: I (indiscernible) data point. The new trucking CSA rule that went into effect July 1, we're not really seeing any impact from that right now, but we do expect over time that there will be an impact from that, which will make rail more competitive -- intermodal more competitive.
Ken Hoexter - Bank of America: You're talking about hours of service, right?
Eric L. Butler - EVP, Marketing and Sales: Yes.
Ken Hoexter - Bank of America: I guess my other question is -- I think Rob mentioned during his speech that more manifest will drive a need for more employees. Should we see that pace accelerate, given some of the comments on the areas you're targeting, whether it's (crude by rail) or some of the other areas that might be more manifest? Should we see that pace of employees pick up now?
John J. Koraleski - President and CEO: Rob?
Robert M. Knight, Jr. - EVP and CFO: Ken, it depends on the volumes, and the mix is a part of it, but anyway I go back to our original guidance on headcount. We put capital aside because, as I commented, some of our headcount was earmarked on the capital and specifically (how the trains go), but if you look at -- our net headcount should flow with volumes. So if volume is slightly up, I'll expect headcount in that to be slightly up. If volume is going to be slightly down, for example, which I don't hope – I don't want that to happen, but if that were to happen, we expect headcount to be down, but not – all of which not one for one because there is productivity in there. So I think while manifest itself carries with it a little bit more labor intensity, when you step back and look at it enterprise-wide, that doesn't change our view on our headcount guidance.
Operator: Allison Landry, Credit Suisse Group.
Allison Landry - Credit Suisse Group: I was wondering if you could provide any detail on the volumes that were associated with the utility outages and the new business that you mentioned for the coal business. Specifically did the new business that you were talking about include any legacy coal business that was re-priced for 2012 but did not move?
John J. Koraleski - President and CEO: Eric?
Eric L. Butler - EVP, Marketing and Sales: Allison, if I understand your question you're asking, in the second quarter, what was the impact of some of the legacy repricing – business that did not move. Let me simply answer and if don't answer correctly what you're asking, come back. We have prudently said that as we reprice contracts, if the volume doesn't move and we called this out in the first quarter there, we didn't get, call it, half a point of price because we repriced business, the volume was down. We're still experiencing that. While we have sequential improvement in our volumes in our coal business, it's still not at the rate that – the full load rate, if you will, back to historical levels. So I would summarize by saying that if coal volumes would have picked back up to historical levels, there is still some upside opportunity there. Depending on when it actually happens, it may or may not show up in how we report our pricing, but rest assured it would show up in our margins.
Allison Landry - Credit Suisse Group: Is there any volume number that you could give us for the utility outage that you mentioned?
Eric L. Butler - EVP, Marketing and Sales: I mean, it's in our number, it's been mentioned in our numbers, but we don't call it out specifically.
Allison Landry - Credit Suisse Group: Then, my final question on crude by rail, you talked a lot about the destination side of the equation, but I was wondering if you could speak to production ramping up in the Niobrara and how many rail facilities that you might put there on the origination side?
John J. Koraleski - President and CEO: Eric?
Eric L. Butler - EVP, Marketing and Sales: So, as you know, production in Niobrara is ramping up and it still is at much lower levels than what you have seen out of Bakken or out of some of the Canadian areas. There are – in terms of new or – our customers and destination origin, terminal owners, there are a number of large projects underway, I'm not going to call out the specifics, but a number of large projects both on ourselves and on our competitors that are underway in terms of origin facilities out of the Niobrara, those are really targeted to move Niobrara product into California.
Operator: Brandon Oglenski, Barclays.
Brandon Oglenski - Barclays Capital: I want to follow-up from the question that Kim was asking on intermodal, you guys mentioned your new Santa Teresa facility that's ramping up, does that mean that sale mix is going to jump little bit more aggressively into the cross border Intermodal business with partnership with UP?
Eric L. Butler - EVP, Marketing and Sales: Our Santa Teresa facility that Jack was talking about is targeted to open in the first quarter of next year. That facility is on UP and that will do a of things for us, but one of things that it'll do, they will help us really penetrate in that maquiladora market that is just South of the border and moving that product to destination and the U.S. by long-haul truck, we will be able to convert that to intermodal and move to intermodal. So that’s not really an FXE play. It would not surprise me if the FXE is interested in growing their intermodal business. They have a great franchise as does the KCSM. As I said before, there is a rich target opportunity there in terms of intermodal, particularly to and from Mexico. So, it would surprise me if that were the case.
Brandon Oglenski - Barclays Capital: Maybe Eric or Jack, if you guys want to expand on this one as well, but I think the risk that could develop here is that if the full economy continues, do you think that Union Pacific can continue driving core pricing growth in the 4% range? I know there was some legacy contracts last year. You are getting all the bit more benefit this year, but our understanding that you don’t have a significant book of business to reprice early in 2014. So, do you envision that as things kind of continue at the 2Q pace, you could maintain that (overall) pricing growth or is a little bit of risk in the economy there as well?
Robert M. Knight, Jr. - EVP and CFO: Let me just remind everyone what we said. Again, we haven’t given guidance on specific pricing number other than to say that we are confident we can still get real pricing which some and many have defined that as sort of inflation plus kind of pricing. But as we talked before, we are focused on making sure that every piece of business is re-investable. But to your point of legacy, I have called out that 2014 'legacy light year', but that doesn’t change our overall focus on pricing and our commitment to get that real core pricing gains.
Operator: Matthew Troy, Susquehanna Financial Group.
Matthew Troy - Susquehanna Financial Group: Given the market's evident enthusiasm with the Mexican businesses evidenced by Kansas City Southern multiple, so it is worth noting you guys have on an absolute basis an equally sized –somewhat equally sized Mexican business. Perhaps if you could just talk about – I know we have touched on intermodal, but some of the growth that you saw in the second quarter, how that business is trending? In terms of near-shoring and (biz) development, what does the pipeline look like in terms of what might be coming online in Mexico to drive further and future growth?
Eric L. Butler - EVP, Marketing and Sales: So we are very excited about the Mexico market. As you may or may not know, we are still the Kansas City Southern de Mexico, KCSM, largest interline partner to and from Mexico. So we are excited about the franchise. We're excited about all of the opportunities. There is immense growth on the auto side of the business. There is a number of different automotive facilities that are being built and expanded in Mexico and between the KCSM and the FXE joined with the UP franchise, that's a sweet spot for us. The Mexican grain business is always very strong for us. With the drought last year, we have seen some weakness but as you have normal crop yields, that is always a target area for us. Then intermodal, it's really kind of the untapped area. There is a significant amount of intermodal today in terms of what the auto manufacturers, but if you take the auto manufacturers out of the mix, there is significant North/South truck moves. We believe that that's an untapped area for us to penetrate and grow our Mexico business. So we are very excited about Mexico.
Matthew Troy - Susquehanna Financial Group: I guess my follow-up question would be a longer term, we are starting to hear and see conceptual, stigmatic and models of natural gas powered locomotives, certainly the manufacturers are starting to talk about it more in potential for savings operationally of 20%, 30% in terms of running cost. Again, this is all kind of theoretical at this point, but to what extent are you examining natural gas locomotives in beta testing, where are you in that and realistically what might be a timeframe to see something deployed in a commercial basis?
Lance M. Fritz - EVP,Operations: Sure. Yes, so there is a lot of work both in Union Pacific and in the industry on natural gas powered locomotives. We are positioning ourselves right now to start running some beta testing, we have been partnered up with the (CN), they used some of our equipment when you were beta testing and have seen their results. It is not a layup from the standpoint of running a reasonable return out of the investment necessary to convert to natural gas. There is a significant capital footprint on the network and there is also a significant capital put into the rolling stocks (fleet) tenders behind locomotives. However, it looks promising, so we’re investigating and pursuing.
Operator: Anthony Gallo, Wells Fargo.
Anthony Gallo - Wells Fargo: My question is on the agriculture business. 2Q '13 volumes, I think was the second lowest going back to 2007, so two questions really, has there been any change other than say the droughts on your network with either customers coming on or off the network, and then secondly, what have been the implications for you from an expense standpoint and how does that resolve itself as volumes eventually comeback?
John J. Koraleski - President and CEO: Eric?
Eric L. Butler - EVP, Marketing and Sales: Let me talk about kind of the network. We actually have been expanding our Ag network footprint as we've gone through the drought period. We have invested and have created with our customers more originations, and we have expanded our capability in terms of running larger, more efficient trains in our network. So while the drought has underway, we have actually positioned ourselves for the future to grow the business. If you look at the Ag business, yes, it was near record lows, but there are a couple of factors. We had the drought. We also had during this time, don't forget – we had the Russian and Chinese governments putting bans on some of our exports. We had our sugar exports being impacted also in terms of Mexico, so all of those factors have impacted the volumes while we've had this drought. In terms of our corn crop that everyone is focused on, so it's almost like a perfect storm, but we feel pretty good about the future. Assuming normal trend line yields, our network is probably in better shape now than we were going into it in terms of being able to handle the upside.
Operator: Jason Seidl, Cowen & Co.
Jason Seidl - Cowen & Co.: Quick question on the core pricing games of 4%. As we look into the back half of the year, sort of all things being equal, if you do get that lift from domestic coal, if weather does cooperate with, at least the core pricing numbers go up, because of the previous legacy renewals?
John J. Koraleski - President and CEO: Bob?
Robert M. Knight, Jr. - EVP and CFO: Yeah, Jason, you're correct. I mean, just the math of it is as some of those legacy contracts that we repriced, if the volume increases, that's a benefit for us this year. So we'll roughly see how it plays out.
Jason Seidl - Cowen & Co.: Sticking with the coal theme for my follow-up, how is the PRB looking in terms of sort of going to get some Eastern burn going forward? I know we've seen a little bit of a switch out from some of the Eastern plants (Southern River Basin). Is there any room for PRB to pick up some steam?
John J. Koraleski - President and CEO: Eric?
Eric L. Butler - EVP, Marketing and Sales: No. Eastern utilities, they have a choice between PRB, they have the choice between Illinois coal, they have a choice between Central Appalachian coal, and the decision is really different for different utilities based on where they are in terms of scrubbers and other environmental investments that they have made, the materials that they would need to cleanse the coal, like lime. So I mean it's a different equation for every utility and I think every utility is looking at that equation and the mix of what they want to do. In that context, we are continuing to have discussions with Eastern utilities.
Jason Seidl - Cowen & Co.: But you think there's a good chance that that could pick up in the future?
Eric L. Butler - EVP, Marketing and Sales: Eastern utilities, they are making these decisions. They are investigating Southern Powder River basin coal as one of numerous options. We are excited about that. We want to facilitate that, but there are a lot of factors that go in to their discussion.
Operator: John Larkin, Stifel.
John Larkin - Stifel Nicolaus: Rob, would you care to talk about the magnitude of the fuel surcharge lag impact in the quarter? Could you kindly hang a number on that for us?
Robert M. Knight, Jr. - EVP and CFO: Yeah, John, I'd say it was a tailwind that, when you consider the recovery of the lag, the price of the fuel et cetera, it was a tailwind of $0.01 or so.
John Larkin - Stifel Nicolaus: So not a major factor in the quarter. Also on your expense side, worldwide volumes were down 0.5% to 1%, expenses were up 3%, which seems to run in the face a little bit of the company's long running objective to try and offset cost inflation with productivity. Was the mix in traffic to more manifest the main driver of that or was there something else going on?
John J. Koraleski - President and CEO: Rob?
Robert M. Knight, Jr. - EVP and CFO: Yeah, John, as I commented earlier, manifest was a part of it. I could talk about the personal injury items while improved safety performance year-over-year it wasn't as good as last year's prior period adjustment, so that's a factor. Headcount, our hiring as we talk about, we are hiring partly manifest partly just getting ahead of the curve on some other replacement activities was a part of the activity as well.
Operator: Walter Spracklinm, RBC Capital Markets.
Walter Spracklin - RBC Capital Markets: Mine are two just kind of follow-up questions. First on intermodal, can you tell us on the domestic side whether all of your growth right now is coming from conversions or is there any, in other words, is the economy playing at all a negative, flat or a positive factor on your domestic side or is your entire growth coming from truck to rail conversion?
John J. Koraleski - President and CEO: I would use the – that's a two-thirds, one-third, two-third conversion, one-thirds economy, so the majority of our growth is coming from conversion.
Walter Spracklin - RBC Capital Markets: In terms of your employee count, just a follow-up on that, you had mentioned that you wanted to grow your employee count somewhere less than volume. It seems that it's growing at least more than volume in the first half, so is that to indicate that we should see reduction in your employee count in the back half of the year. Am I reading that right?
John J. Koraleski - President and CEO: That would be pretty hard to fix, so if you look at it Walter right now, about half of that employee count was driven by capital spending, PTC investment and those kinds of things. One of the phenomena that we're seeing right at the moment is hiring or the replacement of people who will be retiring and leaving the workforce. So, we have probably a few extra people at this point in time because they are training for the second half of the year and those kinds of things. But I don't think it's going to change. I don't know Rob, do you see it differently.
Robert M. Knight, Jr. - EVP and CFO: Well mix is a point of factor, but again our overall guidance is a net effect of headcount, when you shift capital aside, we'll be up or down with volume – with the assumption that we will continue to get productivity behind that.
Walter Spracklin - RBC Capital Markets: So, roughly how much of your guys here are capital people that are compared to last year. How many have you added for capital purposes versus last year?
John J. Koraleski - President and CEO: Robert had said it was about half of our growth in headcount was capital and about half was driven by other.
Operator: Keith Schoonmaker, Morningstar.
Keith Schoonmaker - Morningstar: A follow-up on PRB, I think at the investor meeting at October, you mentioned export coal might be 7 million or 8 million tons this year. Does that still seem reasonable and could you add any color to that smaller part of the franchise?
Eric L. Butler - EVP, Marketing and Sales: Last year we had about 7.6 million tons of export which I think was a record year. We might have couple points higher than that, we might end up at 7.8 this year. Frankly the export market was somewhat disappointing this year given some of the economic difficulties, particularly in Europe, less so in Asia, we do expect that as the world economy grows that the export market should strengthen and there will be upside to that, but this year will be a little higher, call it, around 8 million tons averaging out.
Keith Schoonmaker - Morningstar: Eric, is this exporting through Huston to Europe, is that right
Eric L. Butler - EVP, Marketing and Sales: We have exports from our networks going through the Gulf and we also have exports going off West coast to Asia.
Keith Schoonmaker - Morningstar: Then switching subjects to PTC, I guess. As PTC spend is becoming more fully implemented and larger, do you at this point as you're getting close to the large spend this year foresee any economic benefit from this?
Lance M. Fritz - EVP,Operations: Sure. The short answer is, no. So just level set for everybody, PTC is an overlay system that sits on top of what we already have. It only is designed to do four things, all of essentially stopping trains prior to an incident. There is no productivity benefit to that. As a matter of fact, we are managing the project very aggressively. So we don't get hit by a productivity hit, because the only thing that could happen is if the system isn't working well, it could reduce our effective capacity. So we are working very hard not to let that happen.
Operator: David Vernon, Bernstein Research.
David Vernon - Bernstein Research: I think you mentioned in the third quarter guidance for ad volume we'll be down slightly and I guess I was just trying to get some help figuring out how if we get the crop that we planted for, that volume could recover kind of as we move into 2014.
Eric L. Butler - EVP, Marketing and Sales: Their crops really impact the fourth quarter. The harvest really doesn't start until late in the third quarter, late September. So it's really crop coming in as a fourth quarter impact.
David Vernon - Bernstein Research: So the majority of the recovery there should start sort of mid-fourth quarter?
Eric L. Butler - EVP, Marketing and Sales: Yes, that would be our expectation, David.
David Vernon - Bernstein Research: Then one last quick one. With the mix of export moves that you have relative to utility, do you have a sense for the average length of haul between those two chunks? I know the total coal business is in the 960, 970 range. I was just really trying to figure out if exports is longer-haul or shorter-haul than your average utility move?
Eric L. Butler - EVP, Marketing and Sales: I guess kind of Houston would be about the same and then be a little longer to California, but I don't think it's going to be a big issue.
John J. Koraleski - President and CEO: Tonnage is so small, it's just...
Eric L. Butler - EVP, Marketing and Sales: Yeah, it's such a small tonnage, I don't think it's going to move any of our numbers.
Operator: Mr. Koraleski, I turn the floor back to you for closing comments.
John J. Koraleski - President and CEO: Great. Thank you so much for joining us on the call today. We’re looking forward to speaking with you again in October.
Operator: This includes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.