Canadian Pacific Kansas City Ltd. (CP) Q3 2013 Earnings Report, Transcript and Summary

David L. Starling - Chief Executive Officer, President, Director, Chief Executive Officer of The Kansas City Southern Railway Company and President of The Kansas City Southern Railway Company David R. Ebbrecht - Chief Operating Officer, Executive Vice President, Chief Operating Officer of The Kansas City Southern Railway Company and Executive Vice President of The Kansas City Southern Railway Company Patrick J. Ottensmeyer - Executive Vice President of Sales & Marketing Michael W. Upchurch - Chief Financial Officer and Executive Vice President José L. Zozaya - President of KCSM

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division Christian Wetherbee - Citigroup Inc, Research Division William J. Greene - Morgan Stanley, Research Division Ken Hoexter - BofA Merrill Lynch, Research Division Allison M. Landry - Crédit Suisse AG, Research Division Justin Long - Stephens Inc., Research Division Brandon R. Oglenski - Barclays Capital, Research Division Scott H. Group - Wolfe Research, LLC Thomas Kim - Goldman Sachs Group Inc., Research Division Jason H. Seidl - Cowen Securities LLC, Research Division Jason H. Seidl - Cowen and Company, LLC, Research Division Keith Schoonmaker - Morningstar Inc., Research Division Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

Greetings, and welcome to the Kansas City Southern Third Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. This presentation includes statements concerning potential future events involving the company, which could materially differ from events that actually occur. The differences could be caused by a number of factors, including those factors identified in the Risk Factors section of the company's Form 10-K for the year ending December 31, 2012, filed with the SEC. The company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found at the KCS website, www.kcsouthern.com. It is now my pleasure to introduce your host, David Starling, President and Chief Executive Officer for Kansas City Southern. Mr. Starling, you may begin.

Good morning, and welcome to the Kansas City Southern's third quarter conference call. Joining me as presenters this morning are Dave Ebbrecht, EVP and Chief Operating Officer; Pat Ottensmeyer; EVP of Sales and Marketing; and Mike Upchurch, EVP and Chief Financial Officer. Also, José Zozaya, our President and Executive Rep of KCSM will be available for questions later on this call. We will start with our third quarter overview. In light of the stubborn, unsettled economy, we feel good to have achieved a record quarter revenue growth of 8%. This past quarter illustrated that the diversity of KCS' commodity mix allows us to more than compensate for periodic shortfalls in particular business areas by achieving strong growth in others. Typically, KCS' coal business is solid in the third quarter. However, this year, a mild summer and low natural gas prices contributed to coal revenues being down 2%. Also hurting us was the decision of one of our coal customers to shut down 2 generating units in one of our plants on October 1, rather than December; that's when they did it last year. Their decision to shut down earlier resulted in reduced coal shipments for that plant in the third quarter. Another area in which third quarter revenues fall so much short of our expectations was in our crude business. While revenues from crude carloads were up 8%, that's a far cry from the 195% revenue increase we reported in the second quarter. The slowdown was directly related to the impact of narrowing spreads between WTI and Brent prices. Our Bakken and Eagle Ford car-loadings are certainly down, but heavy crude car-loading from Canada had remained fairly strong. But these less than spectacular developments were more than offset by other commodities. For example: revenue from metals were up 16%; grain was up 11% due to a late surge in the quarter; petroleum coke was up 39%; and cross-border revenue grew by 16% and accounted for nearly 24% of total consolidated revenues. And of course, our cross-border intermodal growth continued at an exceptional pace, increasing by 73%. The importance of this diverse mix of business cannot be overstated. Railroads operate in environments in which markets can change quickly and dramatically due to economic and weather conditions, as well as a host of other market dynamics. Having a diverse commodity mix provides greater stability and can allow for strong growth even when the market shifts occur. This certainly held through in our third quarter. Also holding through was a continuation of excellent operating performance, which was a prime contributor to KCS attaining a third quarter operating ratio of 67.8%. Our OR was tracking a bit better into the quarter, but our system was hit by tropical storms in Mexico, which added some operating expense while costing us some revenue. The fact is, railroading is an outdoor sport, and we just have to roll with those circumstances. Finally, it's definitely worth noting that the great drought-induced grain nightmare is over. Not only did we [indiscernible] late in the quarter, so far in the fourth quarter, our export grain loadings are up in the very high double digits from a year ago and should continue to be strong throughout the quarter. The next chart, Third Quarter Results, just summarizes our third quarter results and doesn't need any extensive remarks from me. Pat and Mike will provide more detail. Let's go to the next slide, the Update for Q3. Carloads are up 3%. While that's a pretty solid number, given market conditions and tepid economic growth, it's a little shy of what we had expected. As I mentioned earlier, coal and crude were not as strong as we had thought they would be. Also, automotive car-loadings were flat due to tough year-over-year comps, plus the fact that a number of the plants we're serving are operating near capacity due to the growing demand for vehicles made in Mexico. While this capacity situation will impact us in the short run, the situation will begin to improve in 2014 with the 3 new plants coming online, and we're looking forward to continued capacity expansion through 2018. And Pat will provide more color on the autos. There is still too many economic uncertainty for us to be able to make an exact carload growth projection for the year, but we do believe we'll end 2013 on a strong note, and certainly our strong fourth quarter grain shipments will help. With the exception of our long-term coal contracts, which are based on rail inflation index, our coal pricing remains well above inflation, and Pat will discuss more detail on pricing. Through 3 quarters, our revenue growth is 5%, in line with our mid-single digit projection. We expect a good revenue quarter, so we're very optimistic of hitting our 2013 revenue growth target. Lastly, we had improved our operating ratio by 1 point for the first 3 quarters, and believe that, barring unforeseen circumstances, we should have good OR performance in the fourth quarter. So with that, I'll turn the presentation over to Dave Ebbrecht, but will come back at the end to sum things up and provide some thoughts as for the fourth quarter. Dave?

Thanks, David, and good morning. Let's turn to Slide 9. This chart continues to represent our ability to control costs and depicts a significant upswing in volume we have seen towards the end of the quarter. Operations has done a good job of accommodating the growth, especially considering that we had significant manifest growth through Shreveport and the Meridian Speedway. Shreveport handled 8,400 cars more, and Jackson handled 6,600 cars more, mostly during the second half of the quarter. Our modeling efforts continue to be accurate for our locomotive and car fleet demand to accommodate our growth profile. Accordingly, we have been continuously growing our railcar fleets. And we'll start to receive our 35 new engines in November to accommodate the volume surge in the fourth quarter, which has been dominated by the resurgence of long-haul grain. Overall, we'll continue to see a positive trend and remain relatively flat on expenses for the foreseeable future. On Slide 10, on the bar portion of the chart, you can see our headcount continues to slightly increase with our recent in-sourcing of contracted services in Mexico. But we'll continue to scale headcount well below our volume increases. We also held back on reducing our crew base associated with our grain routings during the second and third quarter. And now we're in very good shape given the grain has come back in full swing. In the future, we will see increased traffic build on our secondary lines. This will enable us to more fully allocate our train crews and support staff against the larger volumes of demand and provide further economies of scale. We'll continue to hire in areas we need to accommodate our high-growth profile, but our trend will continue to show increased productivity. On Slide 11, some of our operating metrics saw slight variations in the third quarter, but they are still indicative of very solid performance, and well above the range needed to execute our transportation service plan: velocity was at 27.2 miles per hour and better than the third quarter of 2012; dwell was at 19.9 versus 18.3 the year prior, and mostly due to the increased volume of cars processed through Shreveport and Jackson. Increased volumes through higher dwell processing terminals will naturally elevate our system dwell and increases the cars online, but have no material impact on efficiency or connectivity. There was a slight degradation of our efficiency metrics in Mexico when tropical storm Manuel hit during Mexican Independence Day on September 16, and caused a weeklong disruption between Mexico City and Lázaro Cárdenas. Maintenance away also had major activity on our line between Shreveport and Kansas City that increased the disturbed track slow orders during the quarter. We'll continue to accommodate our growth projections and change the operations necessary to optimize our efficiencies. Now, I'll turn it over to Pat for sales and marketing update.

Okay. Good morning, everyone. I will begin my comments on Slide 13. As you saw earlier, revenues for the third quarter were $621.6 million, up 8% from last year and a new record for any quarter in our company's history. Carloads was 3% higher than last year and also a new quarterly record. As you can see on this slide, revenues were higher in all 6 of our major business units, including Ag & Minerals, which is the first time that we've seen that all year. Foreign exchange was a very slight positive during the quarter, adding about $1.2 million in total revenues, or less than 1%. Revenues in our Chemical & Petroleum business were 3% higher, in spite of a 1% decline in volumes. Reduced shipments from 2 major customers, both in Mexico, more than explained the volume reduction in this entire business unit during the quarter. These are both temporary situations relating to weather, and some shifts in electricity production that reduced our fuel oil shipments to power plants in Mexico during the quarter. As a result, our petroleum business showed lower volumes and revenues of 12% and 3%, respectively, versus last year. Both of these customers are expected to return to more normal levels during the fourth quarter. You will also recall that we report crude oil shipments in our Energy business unit, and not in this one. Revenues in our Industrial & Consumer business grew by 7% on flat volumes from last year. Metals and scrap were the primary growth drivers, with revenues and volumes increasing by 16% and 7%, respectively. We saw particularly strong cross-border shipments in this commodity group, with cross-border revenues and volumes both increasing by more than 40% versus last year. Appliances, while small, and scrap paper shipments, were also strong during the quarter. Average length of haul increased by about 5% in this business, largely driven by the increase in cross-border shipments. Lumber, Plywood and Other were the weaker performers in this group. As I mentioned earlier, we saw year-over-year growth in Ag & Minerals for the first time this year, with volumes up 6% and revenues up 7%, versus last year. Grain shipments in the southern U.S. part of our network, Mississippi and Louisiana, began to pick up in September and we saw particularly -- particular strength in export grain during the quarter. Revenues for export increased by 13% on volume growth of 15%. Ores and Minerals were also strong with revenue growth of 22% and volume of 28%. We're seeing some recovery of sand and rock shipments into the Haynesville shale region around Shreveport, which were very low last year. I'll talk more about crop conditions and the grain outlook in a few moments. Our Energy business unit recorded revenue growth of 6% on volume growth of 2%. There's a bit of a story behind these numbers, and that is that utility coal was weak, as Dave mentioned earlier, with volumes and revenues declining by 6% and 2%, respectively. And all other commodities increased in this group. Frac sand and pet coke were particularly strong and crude oil continued to grow, but at a lower rate than we've seen in prior quarters. Pet coke revenue was, as Dave mentioned, 39% higher than last year due to the increased export shipments from the Motiva refinery in Port Arthur, Texas. We expect this business to continue at current levels going forward. Frac sand revenues increased by 22% on volume growth of 15%, as we saw strong shipments in all of the producing regions that we served during the quarter, including Haynesville, as I mentioned earlier. Crude oil revenues increased by 8% on about a 1% volume increase. We did see significant declines in crude shipments that -- out of the Bakken region and West Texas due to compression of commodity spreads. We're still seeing good activity and strength from Western Canada. And there has been some modest recovery of Bakken shipments recently, as spreads have widened. As for the outlook for Port Arthur Crude Terminal, that project continues to move along through due diligence, and there have been no major surprises. However, we are not in a position to announce further details of that agreement at this time. We did complete the purchase of 29 acres adjacent to our land in Port Arthur this week -- in fact, we are closing today -- which will give us access to a barge loading facility adjacent to that property. I think we talked about this property purchase on the second quarter call. And this property acquisition is clearly an indicator of our confidence that the larger terminal project that we've discussed will move forward and eventually will be completed. Intermodal continues its very solid growth rates, with revenues increasing by 17% on volume growth of 6%. The main driver here, as in the past, is Cross-border Intermodal, which recorded revenue growth of 73% on volume growth of 71%. Revenues related to Lázaro Cárdenas business grew by 4% on a 3% decline in units, which was the first time ever that we have seen volume decline at Lázaro Cárdenas. I'll talk more about that in a couple of minutes. Finally, revenues in our Automotive business grew by 7% on volumes that were essentially flat to last year. This also is a bit of a departure from previous quarters where we've seen growth rates in the mid-teens or even higher. Automobile production at plants we serve in Mexico declined by about 7% versus third quarter of 2012, with the biggest drop in production occurring at a Volkswagen plant in Puebla, which is the largest plant in Mexico, and one of our largest shippers. We know that the Puebla VW plant operated at very high capacity utilization last year. In fact, it was over 100%. And third quarter production -- levels of production for 2013 were in the 93% utilization level, in part due to a slow start following the Mexican Independence Day holiday. We also saw some production declines from a large customer due to unexpected quality holds following a model changeover. That is not the case going forward. Again, we'll talk about the auto outlook more in a few moments. Slide 14, you can see our cross-border revenue surged in the third quarter to an all-time record level of $147 million, and represented almost half of our total revenue growth during the quarter. All business units recorded gains from last year, with the main drivers being: Intermodal; Industrial & Consumer, primarily the steel and appliance shipments I talked about earlier; Ag & Minerals; and Automotive. Cross-border grain grew by 26% from last year, and this was the first quarter since -- first quarter of 2012 that we saw year-over-year growth in cross-border grain. This should continue to be a source of strength into the foreseeable future. On Slide 15, we show the revenue growth attributed to our 5 strategic growth areas, which this quarter was a combined 16%, or double our overall revenue growth rate for the quarter. Cross-border intermodal and frac sand were the primary drivers, with growth rates of 73% and 22%, as you can see on the chart. As I mentioned earlier, our crude oil shipments out of the Bakken region fell pretty dramatically due to commodity spreads that made rail shipments uncompetitive from that region. The WTI/Brent spread has recently widened to levels that we believe will move crude oil by rail. And, in fact, we've seen some modest recovery of Bakken shipments very recently. Our shipments from Western Canada have remained fairly strong. As we've said in the past, long term, we believe the Western Canada crude will be our primary commodity delivered to Port Arthur. The revenue growth of Lázaro Cárdenas was only 4% during the quarter on volume declines of 3%. As I mentioned earlier, this is the first time ever that we have seen volumes fall at Lázaro. There are a couple of major factors that explain what's going on there. The most significant is a dramatic reduction in aluminum shipments for 1 particular customer that resulted in a reduction of over 10,000 units compared to last year. So call that an unfavorable comp. And adjusting for that reduction in that 1 particular customer, all other volume increased by about 18% from last year. We will have a similar bad comp situation in the fourth quarter of this year, but should be back to normal comps beginning next year. In addition, as Dave Ebbrecht mentioned, we experienced some network interruptions due to flooding in Southern Mexico during the quarter. And we estimate that cost us about 2,500 units during the quarter. Adjusting for this, which we believe is timing, as the highways were also out of service during that period, we would've seen volumes increase by about 2%. As I've mentioned before, looking longer term, Lázaro Cárdenas will be a very important strategic growth area for us. The new APM Terminal is under construction and scheduled to open in early 2015. And our pipeline of new business opportunities continues to grow. Moving on to Slide 16. As Dave Starling mentioned earlier, our market outlook hasn't changed significantly since we showed you this in April. And we're still looking for mid-single digit revenue growth for the full year 2013 on a consolidated basis. However, you will see on this slide that the market outlook for some of the business units has changed since our last report: Ag & Minerals is a little stronger, driven primarily by better-than-expected shipments in the third quarter and a strong outlook for the fourth quarter. Again, this will be driven primarily by growth in export and cross-border grain shipments. Our outlook for the Energy business is a little weaker than we expected in April, driven by reduction in Bakken crude oil shipments, as I mentioned, and weaker outlook for utility coal. As many of you know, and Dave mentioned earlier, one of our power plants we serve in Texas has become a seasonal producer, with the season being the summer cooling period. This isn't a new development. We saw the same situation last year. We just weren't certain that it would happen again this year because natural gas prices are higher now than they were a year ago. We have to assume this is going to be a recurring issue in 2014 and possibly beyond. That probably means that fourth quarter for utility coal will look a little bit worse than last year, primarily because the outage this year is going to occur in October, versus December last year. And the full year 2013 will be a little worse than all of 2012 for utility coal. However, growth in frac sand and crude oil will still push the Energy business unit overall into positive single-digit territory. We'll update full year 2014 guidance for coal in January. We are still expecting double-digit growth in Automotive for 2013 in spite of a drop in growth rates during the third quarter. As I mentioned earlier, we had some unfavorable comps and quality holds during the third quarter that we do not expect going forward. If you look at our AAR data, our sequential volumes are up in this business more than 20% from third quarter levels. Also, we will begin to see some activity from the new Nissan plant in December. And the Honda and Mazda plants are opening in the Salaya area in the first quarter of 2014. Finally, on Slide 17, as Dave mentioned, the much anticipated grain crop is now coming in. And we are beginning to see strength in our export and cross-border business in September that should continue into 2014. The addition of the 2 new shuttle loading facilities that opened this summer on our network will make our grain franchise even stronger than it already was. Cross-border intermodal will continue to be a significant growth driver going forward. And in spite of our exceptional growth here for the last several years, we are still barely at 3% market share of the estimated 3 million truck market, so there continues to be tremendous opportunity for truck-to-rail conversions and growth in this business for a long time to come. We are also seeing some renewed and stronger interest in international cross-border from some of the ocean carriers that call on Lázaro Cárdenas, primarily into the Houston and Gulf Coast markets. I believe we will be talking more about this in 2014 and the years ahead. We continue to feel good about the current pricing environment and outlook. If we exclude the impact of our long-term coal contracts, which as Dave mentioned are generally priced off of rail inflation indexes that have been very low recently, we continue to see mid-single digit pricing increases in the rest of our business. We do not see that changing in the near future. Finally, our new business pipeline is strong and growing. We've talked a lot about the new auto plants that are coming online, steel facilities, grain elevators and, of course, the new emerging energy opportunities. Next year, you will hear us talking more about some of the ethane and propane refineries that are planned for the U.S. Gulf Coast. And hopefully, we will be talking a lot more about new opportunities that will be made possible by energy reform in Mexico. With that, I will turn the presentation over to Mike Upchurch.

Thanks, Pat, and good morning, everyone. I'd like to start my comments on Slide 19 and provide a few key highlights on our income statement. First of all, revenues had indicated, increased 8%, well above our volume growth of 3%. Expenses increased 6%, providing incremental margins of 44% in an operating ratio of 67.8% for the quarter. Interest expense continued to decline $6 million year-over-year or approximately 25% as a result of our refinancing activity during the second quarter. Our average effective interest rate was 4% for this quarter compared to almost 6% in the third quarter of 2012. The peso ended the quarter at about the same rate as the second quarter and resulted in about a $1 million loss. Also, during the quarter, we repurchased $13 million of our 6 1/8 KCSM notes and incurred $2.4 million in debt retirement costs associated with the premiums and unamortized debt issuance costs. Our effective income tax rate was 34.7%, consistent with the guidance we provided last quarter. And I'll provide a little bit more detail on that in a few slides. Finally, reported EPS was $1.07, while adjusted EPS was $1.10, up 16% from third quarter of 2012. On Slide 20, we provided a brief reconciliation of recorded to adjusted EPS. And consistent with our prior reporting, we've adjusted for debt retirement costs and FX impacts in the period, and we've also provided some additional details in the appendix for your information. On an adjusted basis, EPS increased 16% to $1.10 per share. Moving to Slide 21. You can see our reconciliation of the U.S. statutory rate of 35%, to the quarter effective tax rate of 34.7%, and what we expect for the full year of 35.5%. As you can see, there is minimal impact this quarter, or for the year, on foreign exchange as the peso has been relatively stable at period end and based on the forward curve of around 13. Moving to Slide 22, I'd like to spend a little bit of time on our operating expenses. Overall, our operating expense trends increased 6% year-over-year, driven primarily by fuel, which accounted for more than 50% of this increase. The other key driver that increased expense was higher depreciation, which resulted from both higher capital expenditures to support our growth and the purchase of assets under lease. And I'll provide more detail on expenses in the next several slides. However, overall, we continue to tightly manage our expenses on a year-over-year basis. On Slide 23, our compensation and benefits expense increased 2.7% to $111 million. The primary drivers behind increased compensation costs were wage inflation and increased headcount. Overall, FTE increased 1.8%. However, excluding the in-sourced contract that we discussed earlier in the year for our truck maintenance in Mexico, FTE was up less than 1%, reflecting, again, strong productivity in our operations group, as volumes grew 3% in the quarter. On Slide 24, let me cover our equipment costs: they declined $3 million year-over-year, largely due to the purchase of leased locomotive completed during the second quarter of 2013. And offsetting those declines were slight increases in car hire, which are the result of increased volumes during the quarter. Moving to fuel expense on Slide 25. Fuel expense increased $103 million due to higher prices and volume. Prices in the U.S. increased from $3 in the third quarter of 2012 to $3.15 in the current quarter or an increase of about 5%. While we saw higher increases in fuel costs in Mexico, second -- or third quarter of 2012, our price per gallon was $2.61 and in the third quarter of 2013, $2.97. So in overall, 14% increase in fuel prices, as Mexico continues to move pricing more closely aligned with global prices. So this is clearly a bit of a differentiator with some of the U.S.-based carriers. Because of rising fuel cost, we estimate the negative lag impact during the quarter to be approximately $3 million, or $0.02 per share. Moving to depreciation on Slide 26. We saw an increase to $57 million in the quarter. Higher capital expenditures contributed $5 million to that increase, while the purchase of leased assets contributed $2 million to the increase in depreciation. And as I mentioned earlier, we saw the offsetting benefit of purchasing leased assets; in the equipment expenses, we saw a reduction of, $4 million as a result of those purchases. Finally, on Slide 27, I'd like to review our capital structure priorities and our cash priorities. First and foremost, we will continue to invest beyond historical industry level to capture the growth opportunity we see in the marketplace. Accordingly, we have slightly increased our CapEx to revenue guidance for the year to 26%, as we placed an order for an additional 10 locomotives during the quarter, so we now have a delivery in a total of 35 units by the end of the year. In addition to ensuring we have the necessary assets in place to deliver our growth plans, we also benefit from bonus depreciation by accepting delivery by the end of the year. And that bonus depreciation, we do not expect to continue into 2014. And that provides a nice tax benefit to us. We also have some additional opportunities to continue optimizing our capital structure. Currently, we are engaged in discussions with various lessors about the possibility to acquire assets under lease. And as you know, this is consistent with our strategy that we've been executing over the last 2 years. Since the interest rate environment continues to be favorable, we believe there is a good return available to KCS by buying equipment under lease. It is important to note that, depending on the purchase price of those assets, it is possible we could incur some lease termination charges that would require us to take a onetime nonrecurring charge. We currently expect any transaction that we execute to be both NPV and earnings accretive, while also benefiting our operating ratio. And depending on the total amount of equipment that would be economically viable for us to acquire, we also have some refinancing opportunities with the remaining 8% and 6.125% notes, which have a total remaining balance of $92 million. So that's something we could certainly roll into a new financing. Finally, we paid a third quarter dividend of $0.215, which amounted to almost $24 million in cash during the quarter. And with that, I'd like to turn the call back over to Dave Starling.

Thanks, Mike. Before opening the call up for questions, I'd like to first reemphasize that we, at KCS, feel very good about our third quarter. As I noted earlier, the strengths of our franchise consistently overcome any periodic weaknesses caused by economic or market conditions or weather. We're every bit as confident that this will continue to be the future. As Pat stated, we feel very good about our new business pipeline, with the new auto plants and the steel facilities opening in Mexico, new grain elevators located in our system and more energy opportunities. The U.S. Gulf continues to provide more opportunities with crude-by-rail, possible new ethane propane refineries, and the new political reforms for the energy sector in Mexico could provide opportunities for our power franchise. We feel very confident that we can execute at a high level on what we can control. And that provides us with an overall positive outlook for the fourth quarter, for instance. With the fear of another poor harvest no longer a threat, KCS' grain carloads should be a record or near record levels from now into 2014. Our cross-border intermodal should continue to grow at high double-digit levels and grain and intermodal should continue to increase KCS' cross-border revenues. Generally, with the exception of coal, we believe the majority of our commodity group should perform well in the months ahead. In addition, our rail operation should continue to be strong, resulting in a continuation of our industry-leading productivity metrics. And you could be assured that we'll maintain stringent control of our operating costs, which will further enhance profitability. We continue to believe that the contributions from all our emerging business opportunities provide us with a degree of confidence that, over the long term, KCS can continue to grow its business at a higher rate than the industry average. While secular economic trends and conditions will certainly play a part in determining what the exact percentages of that growth will be, we believe that KCS has the opportunity to continue to be a growth leader in the transportation space. We remain very bullish on the opportunities our franchise provides for the next several years and beyond. As you all know, railroads have franchises which cannot be duplicated, and we will play a major role in the continued economic growth of North America. With that, I'd be happy to take your questions. We're still going to do one question and one follow-up. And I'll turn it over to you.

[Operator Instructions] Our first question today is coming from Tom Wadewitz from JPMorgan. Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division: Yes. I wanted to ask you about, how you think of sensitivity of your volume growth story to what the Mexican economy does? And we talked a lot about cross-border and driven by new planned investment, and U.S. economy and various things. But how much sensitivity do you think there is to pace the growth in the Mexican economy? And I guess I'm thinking about Lázaro, in particular, which has been slower. Is that something that we should really be thinking about when we look at our forecast for 2014?

Well, I'll start, Tom, and let Pat add the commentary. First of all, Lázaro, what we've had at Lázaro is this comp on the aluminum that kind of was wonderful when we had it. There was a huge movement. It moved -- was shipped in to support a plant, so it was great volume. We're now kind of back into the more normal Mexican market that we're serving. What we think will happen is with a new APM Terminal being built, that you will then have more competition in Lázaro Cárdenas, and we'll have more of an opportunity to take market share from Manzanillo, in addition to enjoying just the organic growth of the economy. So Lázaro is almost a little bit like the cross-border intermodal that could be more market for us to take that is not relative to growth. It would be taking share from Manzanillo. And as far as the Intermodal, we don't see that changing and we don't see the grain movements changing. So again, with the economy in Mexico grows at a smaller rate, we're still going to see the Intermodal grow just because of the conversion. Then the auto plants, Pat, I'll let you talk about the auto plants.

Yes. I think I wouldn't suggest that we are immune or disconnected from what's going on in the economy. We'll certainly be affected by that. But just picking up on what Dave said, one of the factors that I didn't mention about Lázaro that we can't really quantify but, there was a new terminal facility opened in Manzanillo. We think there was some market share shift, perhaps because of the new facility coming on and trying to attract business with pricing. I think the fact that we will have, beginning in 2015, we will have another terminal and some competition at Lázaro will be helpful. The fact is, we have -- we really have 1 terminal operator there now so you don't have that competitive dynamic going on at Lázaro that you do the other Mexican ports. The cross-border intermodal, again, because a lot of that is truck-to-rail conversion of existing traffic, we think that, that could grow even if the economy weakens. But the fact is that business is growing so we're getting the sort of the double whammy on the positive side. We're getting conversion opportunities of existing truck traffic and then that market is growing. And as Dave mentioned, finally, we've -- I think one of the factors that we've seen with auto production in Mexico is capacity utilization is very high in the plants because -- In the plants in Mexico, as I mentioned, we look at some of the capacity utilization figures of the plants we serve and they have been over 100%, which means they're using more overtime. But they've been over 100% of stated capacity for several of the last few quarters. We're going to have about 600,000 or 650,000 new vehicle capacity coming online in the next 4, 5 months. So that should provide a little bit of a cushion and some pickup there. As you know, Nissan is opening in December, and Mazda and Honda are opening in the first quarter of 2014. So not only will we see new vehicles coming out of those plants -- and, obviously, the rate of capacity utilization will be driven by the overall rate of automobile sales -- but as we've said in the past, not just the finished vehicles, we'll see auto parts shipments, we'll see steel and plastics and all of the other things that fit into the finished vehicle funnel. So kind of a long-winded explanation, but we feel pretty optimistic about what's going on in Mexico.

Tom, this is Mike Upchurch. Let me just give you a couple of quick macro data points that we track in our business that are fairly correlated to our carload volumes that might indicate some upward momentum coming out of Mexico. First of all, GDP estimates for the fourth quarter and going into '14 would appear to be 1 point to 1.5 points higher than what we've seen this year. There's a basket index, which is really a measure of domestic consumption, that's been showing some recent strength in Mexico. You also have PMI, which is improving there. And then I think lastly, with the government now largely settled on a number of the strategic initiatives they want to pursue, I think some of the slower government spending that we've seen should begin to accelerate. So all those data points would suggest to us that we're going to see a strengthening environment in Mexico. Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division: Yes, that is great. I appreciate all the color, very helpful answer. My follow-up would be along the same lines, I guess, in terms of outlook: the way I've modeled volumes, I mean you've had about 5% volume growth in 2012. I think, roughly, you're about to say you're 3.5%, 4% this year, assuming we're not way off in the fourth quarter model. And then looking to 2014 and '15, I've got -- assuming it ramps to high single digits, let's call it 9%, 10%. Is that maybe a little bit different from consensus, but I'm guessing that generally people are thinking that way. Is it realistic, given what you see, to see that sharp of a ramp in your volumes if you look out to next year, or to 2015?

Well, we haven't given any specific guidance. As you know, we typically do that in January, on our fourth quarter call. But I think your thought process around acceleration of volumes would certainly seem logical, given some of the ramp-up, in Auto and maybe a slightly improving economy. There are, as you know, uncertainties such as the coal business, and what happens with spreads. But I think the logic of better growth in 2014 certainly holds true, and that's what we believe will happen.

I think the other thing too, Tom, is the grain will carryover into 2014, and we didn't have that last year. So when you didn't have the harvest in the fourth quarter then we had no carryover into '13. But you'll certainly see the grain carrying over into 2014 this year. Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division: Okay, so it sounds like that's not -- it's hard to be precise about it, but it's not an unrealistic framework?

Not at all.

Our next question today is coming from Chris Wetherbee from Citigroup.

I just wanted to maybe start on crude. Pat, you mentioned the closing of the barge terminal, I guess, today. So as you think about kind of getting that piece of property in place, can you talk a little bit about the shorter term opportunity in crude, probably before Port Arthur ultimately gets developed? I just want to get a sense of roughly how you get from where we are right now to the potential of what Port Arthur could bring in 1 year-plus from now.

Okay. There are a couple of other crude facilities and the capacity has been built in the Port Arthur, Beaumont area. We've talked about some of this on prior calls, but there are now 3 facilities that are up and running in that region, in that area that we could deliver crude to. We are also looking at, as I think you may know, we have a pet coke terminal adjacent to the vacant land that we're hoping to build the crude terminal on. There's an existing loop track. There's an existing vessel loader. That's where we run the Motiva pet coke over from their refinery to this facility for export. We're looking at some options in the near term that we could possibly accelerate, reconfigure -- not reconfigure, but configure that facility for possible crude oil shipments, as well. So the capacity has been built. There are other facilities in the Port Arthur, Beaumont area that we can serve, we have access to. There are also other facilities: Lake Charles; we're moving crude oil to a refinery in the Tuscaloosa area; there are a couple of new facilities coming on in the Baton Rouge, New Orleans areas. So capacity is being built. So it's not that -- we don't have to have this Port Arthur crude terminal we've been talking about build before for us to be able to grow in the near term. There is capacity there today that we can serve.

Yes. I might add, Chris, the one facility that Pat talked about will have capital money in for 2014. We're actually going to pull it in to 2013 and start to build more steaming capability on the Tuscaloosa line and another receiving track at Artesia, because the plant we're handling there is at capacity. We need to be able to get more product to them to get it steamed ahead of time. So there's still opportunity there. That one's probably not going to ramp up until I'd say the first quarter, we'll start to see growth there. And then Jefferson Refinery, as Pat mentioned, while they've put the loop track in, they have not finished the steaming capability. So they've still got to add that, put in the steaming capability and that means that the heavy Canadian could come in to Jefferson Refinery, which seems to be much less affected by the spread.

Okay. And I guess that was going to be my follow-up question was about spread sensitivity. Some of those opportunities that you mentioned sound like maybe a little bit more Western Canada-focused. But I wanted to get a rough sense, I think you've shown us in recent slides how some of the Bakken and sort of spot moves can drop off pretty sharply and I think we saw that in the results. Is there a better benchmark that we can use for kind of gauging when you're going to be moving that with the spreads? I mean I think we've expanded a bit here and I think, Pat, you alluded to moving a little bit in the shorter term here, but just to get a rough sense of sort of what your customers tell you about the sensitivity to that?

Well, I think the results kind of speak for themselves. What the customers are saying is that when the WTI/Brent spread gets real tight, it just doesn't make sense to ship out of the Bakken. So I still think that's a valid benchmark. For Western Canada, we're looking at the Maya spreads and Western Canadian Select tells a more accurate picture.

I think there's a lag time on the spreads.

Yes, there is a lag. This isn't like trading bonds or stocks, or something like that. Because of the way crude is priced and the way it's delivered, it could take 60 days or so before -- when the spread widens again, before we actually see it in terms of volumes on the railroad.

Our next question today is coming from Bill Greene from Morgan Stanley.

Pat, can I ask for a little bit more color around your pricing commentary? You're pretty clear on there's a difference between sort of how coal, for example, reprices and how some of the other businesses do. But maybe you can give us a sense more kind of the blend? I don't know how much of the business is actually tied to escalators in any given year and how much of the business is actually gets kind of a renewal that's in this mid-single digit range you referred to?

Well, I would say this, all of our coal business is in some sort of index formula-based pricing. And if you look at some of the rail, economic rail inflation indicators recently, they've been very, very low. So our coal contracts, for the -- well, for the most part, I think, in total, I would -- The way to describe it is they're on autopilot, as far as pricing is concerned, until the contracts expire and we renegotiate the base. So with rail inflation in the U.S. being so low, our rate increases on coal contracts are going to track accordingly. The rest of the business -- yes, I mean, we've got -- some of our other business, obviously, is on contract with pricing escalators or inflation-based escalators. Not a large percentage of that. The other thing that we have mentioned and, again, where we're a little bit different than the other Class 1s is Mexico. The norm in Mexico is that most of the businesses on shorter term, 1 year or less contracts. And so we'll be seeing renewal cycles in the first quarter, heavy renewal cycles, take place in the first quarter of every year in Mexico and, generally speaking, all of our business is repriced in Mexico. There -- I mean, there are some long-term contracts but it's a much smaller percentage of our base than it would be in the U.S. Mexico inflation is a little higher than the U.S. so that's one of the reasons, I think, over time, you'll see our pricing guidance and outlook is maybe a little bit higher than the rest of the industry because of the impact of Mexico, the short length of term and the higher inflation rates in Mexico.

Very helpful. Can I ask one follow-up just on grain? I'm not sure how to think about the mix impact here. Normally, sort of from a seasonal perspective, OR is kind of maybe a little bit better in the fourth quarter, but maybe grain changes that dynamic pretty significantly? Can you just comment, or give any color, on how to think about that?

Well, what, specifically? I guess I'm not sure what you're asking.

Well, so normally you would see about a 50-basis-point improvement or so in OR. But if grain picks up significantly in the fourth quarter, perhaps the mix effect of that could make the outcome far better. And I don't know if that's maybe overstating the impact that grain could have on a quarterly basis or if there's anything about the seasonality to keep in mind there?

Hey, Bill, this is Mike Upchurch. I think the one thing in the grain business, we own most of that equipment or have it on longer-term leases. So when the grain was moving, there was a cost in our P&L. So as that revenue comes back, I think you're right, there'll be a general improvement in the margins from that business, if that's what you're asking about?

Yes. It was just all else held equal, right, seasonality suggests there should be some slight improvement in margins anyway. But does grain make that a bigger change than you'd normally assume? All else held equal, I think the answer is yes, it does. So the fourth quarter looks like a pretty good set up. But I don't want to put words in your mouth, so that's why I was just asking.

We love grain, I'll say that.

Our next question is coming from Ken Hoexter from Merrill Lynch.

Great. Dave, if I can just follow on the grain discussion. Maybe can you talk in terms of scale? I know you've got these 2 new elevators that have opened up on your network and you've got the crop coming online, do the elevators on your network actually add volume or is that more a profit kind of view? And then on the crop itself, can you talk maybe in terms of scale of what you expect and do you have the equipment? Are you prepared to move it? I know Mike just talked and that you own the equipment, but given the size of the rebound do you think you have, are you prepared for that size jump?

I think there were like 5 questions in that string. We'll try to get them. Yes, let me -- let's say it this way. First of all, the crop is the crop and the demand is the demand. So the fact that we've got 2 new elevators on our system doesn't mean that our revenues and volumes and grain are going to increase disproportionately. Our business, as we've said in the past is really consumption-based. Most of the grain that we ship goes into food products, food production, either poultry or corn syrup, soft drinks, that type of thing. We've said in the past kind of jokingly that the official KCS luncheon is chicken tacos and diet soft drinks. So it's consumption-based. But those markets increase modestly. The 2 new elevators that we have, our customers did not build those elevators to retain just the business that they have. They are looking for growth. They're looking for new markets. They're looking for market share conversions. So we will get some incremental pickup as a result of those facilities being on our network. What it really does, one of the big advantages and strategic advantages of having those facilities on our network is it gives us more control over the originations and it gives us more geographic diversity to protect against or mitigate things like drought and flooding and that type of thing. And this is a silly thing to say, but if we had, had those 2 elevators last year, we would've had a much better business levels because, in this case, the areas that -- one in particular, in Western Illinois, the area that this new elevator is serving was less affected by drought than some of the other regions that we serve. So there are lots of strategic advantages to having these 2 new facilities. I will mention one of our customers just recently secured another -- a very large export contract for 2014. We have that contract today, but going forward, the 2014 volumes will represent about 5% or 6% increase in their shipments. And that's a nice cross-border move going from the elevators that we serve down into Central and deep into Mexico, down into Mexico City. I'll let Dave Ebbrecht talk about the capacity issues.

Yes. As far as the capacity issues, there's a couple of things we did. One, we wanted to be able to turn all the sets we had quicker, reduce some of the cycle times. And with the originations coming out of these new plants, we're able to cut the cycle time days for the whole fleet, down a couple of days. That's one way we became more efficient with the fleet. The other thing I also mentioned, we kept from furlough, during the second and third quarter, personnel that were going to be specifically needed for the surge during the fourth quarter. So we're in very good shape from a human resource perspective, as far as people to be able to run the train. And lastly, on the fleet slide -- fleet side, what we did was create some storage contracts that enabled people with grain cars, excess grain cars, to store them on our facility in proximity to our locations needed. And then we would be able to have short-term contracts to use them as needed to surge during the fourth quarter, to accommodate any shortfalls that we may see in transit. So we are very well-positioned, capacity-wise, not only from an infrastructure perspective but from a railcar and people perspective to handle all the surge.

I appreciate that. And if I can do my follow-up then on autos. Similarly, you signed a bunch of contracts you're about to ramp up. Maybe can you give any sense to that timing of when the plant is launched, maybe on scale? And, I don't know if you throw that Manzanillo, the build into that? I don't know -- just to maybe give a perspective on the scale of the ramp-up on the autos, given the contracts and where everything pans out now.

Well, the 3 plants -- as I mentioned, the 3 plants that are opening here in the near term will represent about 600 -- I think the number is around 625,000 finished vehicles. Which is a pretty big increase overall. Just for Mexico: finished vehicles around 2 million; 1.9 million, 1.8 million, I think, last year. But obviously, those plants will ramp-up over a 1- or 2-year period. So we're not going to see a huge surge just because the capacity has been built. And ultimately, will be a function of auto sales, North American auto sales. So we're planning on -- and we will get business out of those plants beginning first quarter of next year. So we're certainly planning to see a stronger year next year in autos than we've seen certainly recently. But I don't know if that's -- to answer you, we're not going to get into details about the timing and specifics about volume growth. But certainly, the fact that those plants are going to be open and we will start moving vehicles in the first quarter of next year.

Our next question is coming from Allison Landry from Crédit Suisse. Allison M. Landry - Crédit Suisse AG, Research Division: I was hoping to dig into the incremental margins a little bit. You mentioned having held back some of the crews in anticipation of the return in grain volumes, plus it sounded like there is a little bit of expenses from the storms in Mexico, and I know that you don't exclude stuff like that, but I just wanted to get some color on what the incremental margins may have looked like, if you did exclude these items? And maybe the better question is, is it fair to assume that we'll see a return to something in the mid-50s range, in Q4 and possibly going forward?

Yes, Allison, this is Mike. You're right, 44% is a little bit lower than what we've had in the past. But I think we've also always tried to maybe guide that 40% to 50% range as something that would be very acceptable to us in this business. But during the quarter, as I indicated, we did have a higher fuel cost, mainly driven by the increase in price in Mexico, which was up 14% year-over-year and that was about a $3 million negative lag in the quarter. So I'll let you do the math and assume how much of that might have improved the incremental margin percentage. And then I think on the hurricane, we don't want to make a big deal out of this. I think Dave indicated this is an outdoor sport business. We did have about $1 million of incremental costs and maybe some lost revenue there, but I don't think we want to sit here and make a lot of excuses for the quarter. I think 67.8% is still a pretty solid number. Allison M. Landry - Crédit Suisse AG, Research Division: Got you, now I totally understood. And my follow-up question on fuel. I noticed that the growth in consumption in terms of gallons was actually higher than volume growth? And it looks like we haven't seen this happen since the second quarter of 2011. So I was wondering if you could maybe talk a little bit about what was going on here?

Yes, I'll tell you, from an operating perspective, if you look at the second half of the quarter, what we saw were high coal shipments and high grain shipments, which consumed a lot of fuel on those unit trains. Also with the growth that we have out of Lázaro, that is one of our highest fuel consumption districts also for trains. So I think it was more of a mix issue of what we had volume-wise during the quarter. And then when you spread that over the manifest that we had, increased through Shreveport Jackson on the Meridian Speedway, we ran 132 extra trains during the quarter over our transportation service plan. Which, obviously, adds to the increased fuel.

Just to pick up here and just to clarify one thing that Dave said about the increase out of Lazaro, he's talking about steel and other commodities, not necessarily Intermodal. We move other things out of Lázaro, so a lot of steel coming out of a plant there going north into Mexico, which does burn a lot of fuel.

You're going up through the mountains, Allison, and coming out of Lázaro. It's our highest burn system, or part of the system, that we have. Allison M. Landry - Crédit Suisse AG, Research Division: Okay, and I guess, sort of along the same lines, with grain coming back quite strongly in the fourth quarter, should we be thinking about consumption above volume growth, once again, for 4Q?

Coal is going to be down. Grain will be up. I don't know exactly...

It should be...

I would say it's going to be relatively the same from what we saw in the third quarter. I don't see any increases.

Good question, we haven't really looked at that.

Our next question today is coming from Justin Long from Stephens Inc.

In 2014, it looks like grain should be strengthening, auto should be getting better with the new plant. I would imagine both of these have a positive mix impact. Is it fair to say that the mix next year should be a tailwind? Or is there something on the horizon that would prevent that from being the case?

Justin, are you calling from a rail yard?

I think that's on your end, I don't know if we have too many trains around our area.

It must be José.

Yes, José, is that you? José L. Zozaya: Yes, that's me. We're in a train yard.

Yes, I think you're right. The mix should be a tailwind next year, with grain being strong. And the other thing I mentioned, I don't think I completely satisfied, Ken, I'll go back to the Auto story. I did make the misstatement: vehicle production mix goes $2.9 million not $1.9 million. So we've got 625,000 additional vehicle capacity coming on stream, with the 3 plants that are set to open. And again, as I said, that will ramp up. The one thing that I will also say about the mix and the auto business that we have secured with these new plants, we have secured more cross-border movements where the vast majority of our auto business, our finished vehicle business today is within intra-Mexico and interchanged at the border. The new plants, with the new business that we secured, we will see a noticeable increase in our cross-border movements which, obviously, has a longer length of haul, longer, higher RPU. So that should be a positive mix impact. There will be, of some kind.

Great. And as a follow-up, I was wondering if there was any update on the new bulk terminal at Lázaro? Are you still having conversations on the export coal opportunity? And how are you thinking about the potential for that facility to ramp in 2014?

We don't see anything happening there on export coal in 2014. Spreads are just too narrow, and we don't really -- we're talking to some people about export coal, but it's not through Mexico, or out of Lazaro. It will be through the U.S. Gulf Coast. But we don't have anything in our plan, or forecast, for 2014.

There's still discussions about shipping coal to Europe. There've been some test burns, but I think it's like the Bakken right now. The spread is a little too wide and it just doesn't make sense right now. What we're being told, it will at some point. They think it will because of the high price of natural gas in Europe, but it hasn't happened yet.

Just as a little fun fact, though. The one thing that we do have with that pet coke export facility in Port Arthur is, we have a facility that is permitted, and has capacity to export pet coke and coal. So that could be a nice thing to have.

Our next question today is coming from Brandon Oglenski from Barclays.

When we look towards these growth opportunities in 2014, and then putting in context the OR expansion that you guys have gotten over the last 3 years, it's been close to 200 basis points a year, should that type of pace of improvement in the OR improve with the growth opportunities? Are you going to get even better leverage? I guess it kind of comes back to the earlier question on incremental margins. And does that picture look better in '14?

This is Dave Starling. I think the position we've taken is we're going to continue to look for efficiencies in our network and we will continue to look for cost savings. And those should affect the OR in a positive way. But if you get a chance to on-board $300 million of business, and it moves the OR from a 66 to a 67 I'll take it. So OR is only one factor that we look at. We certainly -- it's an indicator, but we're also constantly looking at our margins, our revenue and our EPS. So that's just one part of the formula. And as you get down here in the mid-60s, we've got to be cautious here that our customers know that we're spending the right amount of capital and providing the right kind of service to justify the margins we're getting.

And you would view a mid-60s OR as a good hurdle rate for new business?

No, I didn't say that. Every business case will stand on its own. And it will depend on whether we have locomotives, we have to go buy assets, do they furnish the cars, do we furnish the cars? Is this a long-term contract? Is it a short-term opportunity? You've got to look at each business case on its own. You don't -- we don't have just a rate we throw out there and say, "This is our hurdle." So far I think we've made the right decisions in improving the margins we've had. I think the big thing that we're continuing to look at is that leverage that we have, and how we maintain that.

We're going to be very careful about incremental capital investments, generating the right kind of return. And we set hurdles of upper teens. And I think if you look at the growth that we've been able to deliver versus the rest of the industry, and the improvement in margins and the improvement in ROIC, it certainly supports the capital that we've spent.

You may have an opportunity on the branch line that's very underutilized, and you could get some unit trains on that line. That's manna from heaven. That's pure incremental margin. So you've got to look at it from a segment, and look at your whole network.

Well, maybe with my follow-up, if I can just ask it a little bit differently. Because I think the expectation here is that, with the new business, it's going to lever and quite nicely drive a little bit more margin expansion. Is there any sort of startup cost with these new facilities coming online, or, where it takes time to ramp up to get to full profitability on the new business? Or should we be thinking about it as pretty quick, as soon as these new opportunities start, you're going to see the possibilities?

Well, with the capital investments we've been making on capacity, we certainly had been making those in anticipation of growth. So we look out 3 to 5 years. And if that changes, if Pat comes to us and says: "The world's changed, you're not going to see this. It's shifting to another area." Then we will change our capital spend. And we're going to talk to you some in 2014 about our CapEx and what the additional spend in CapEx has done for us, for the company, from a margin standpoint. Because I think we've made the right decisions. Will we get to a point where we can start to ratchet the CapEx down, yes. I think we will. And it will be more activity-based on different projects than we might have to ratchet it up. But I think we're going to benefit, in the coming years, for the amount of CapEx we have spent to get our system robust, make sure we've got the assets and make sure we're ready for the volume. I think you've heard me say on this call several times, one thing I'm not going to be guilty of as CEO is somebody coming in with business, and we can't handle it. So we can't keep the business, we can't make a good margin on it, because we're inefficient. So we'll continue to keep -- we're a growth company, but we're going to continue to keep our capacity out ahead of our growth.

And if you -- I just want to add one thing. If you look at some of the larger -- particularly on the energy side, the larger new business opportunities, the CapEx that we're going to invest is largely locomotives. So we're not going to go out and acquire a huge locomotive fleet to support that business until it actually comes. On the auto side, it's more railcars. And in that case, it's supported by longer-term contracts.

Did that answer your question?

Yes, it did, in great detail.

Our next question today is coming from Scott Group from Wolfe Research.

I just want to follow-up on that discussion that we just had in terms of next year's outlook. As we start thinking about high single-digit growth coming through the network, just from a resource standpoint, I understand, Dave, you're talking earlier about you can add headcount less than volume growth. Is it reasonable to think about another year of like 1% to 2% kind of volume growth? Or, does that naturally just have to be a little bit higher, given the volumes that we expect? And then just from more of a capital and asset perspective, do you feel like you've got all the locomotives and cars that you need to handle the growth? And is there any kind of track projects that you feel like you need, like a Victoria Rosenberg coming up, given all the big growth that we expect? There's a bunch of odd questions in there, but all focused on resources and capital.

Scott, and just to clarify, I think you meant 1% to 2% headcount growth, not volume growth?

Yes, sorry about that.

You're asking if we can still scale to that, with our growth?

Yes, that was one of the questions, yes.

I'll let Dave take that one.

Okay, as far as the resource areas, yes, we can still scale at very low headcount additions with the growth. But given that we know where the growth is coming, there are certain corridors that we will add headcount in, depending on where the growth materializes. We approach each of our subdivisions and look at that capacity and have 5-year plans for each one, and there are certain trigger events that we use to make sure that we have the just-in-time resources for that growth available. But largely, if you look at our network right now, we are not headcount-constrained in any area. But we will continue to hire to replace attrition in a lot of those areas and we will be low, around the 1% to 2% growth area, of what we see against all the plants for the next, at least 1 year, to even more than 2 years in the future. Given that, we'll stay with the growth opportunities that we have and in place. On the track side, we're largely working on our gateway improvements. We believe that a lot of our subdivisions have the capacity to handle the growth that we're projecting. But we'll start talking about major gateways such as the Laredo International Bridge, and looking at the accommodation of the growth through that corridor, where we want to significantly invest to improve our capacity to handle growth over multiple years to come in the future. So we have major projects going along those lines. And on the equipment side, I think Pat addressed it appropriately. We're not going to -- we can handle all the growth we have for next year on the projections right now, with the 35 locomotives we're getting in at the end of this year. And we will look at, towards the end of the year, whether we're properly postured for the fourth quarter through, at least, the second quarter of the upcoming year. So I think that from locomotives side, we're good and the car side, we will address them on customer-specific levels and the contracts that we have in place.

We still got room in our Intermodal and Automotive trains. So we're still, as we've grown those, you're seeing the incremental side of it improve because we're still filling trains out.

That's all really helpful. Just with that view, then, is it fair to think about CapEx coming down next year?

We're going to be meeting with the board in November and going through those plans. It's probably not going to be 26%. So if you ask me, could it come down? Yes, it possibly could. But again, we try to work off of a 5-year plan, and we do our car modeling and locomotive modeling and capacity modeling all based on 5-years. But the board, if the growth is there and the revenue is there, 25% CapEx is not a bad problem if you've got the growth coming with it. But we certainly aren't going to get out too far ahead of ourselves. When we get in some of these lanes, if we've got ample capacity, we'll start to meter it down a little bit. But we're getting in a mix now where we're kind of going to be in the norm with the other railroads in the leased versus owned, but we will be buying some cars as well. I mean, with all this growth, if you're going to be in a double-digit growth, you've got to have cars to load it in, so. We don't have that number yet. We'll be talking to you in the first quarter and we've got auto. I mean, with the autos coming on, we've got to look at some buy levels. And so, again, it's a good problem to have.

Our next question is coming from Thomas Kim from Goldman Sachs.

Sorry to beat a dead horse, but just on this CapEx topic. What do you think your steady-state reinvestment rate should be over the long term? And you sort of alluded to bringing it down closer to your peer group level. So would it be 18%? And is that sort of a 5 year time horizon, or is that a 2020 sort of look that we should be thinking about?

Tom, when I talked about our peers, I was talking about the ownership versus leased of equipments. We have traditionally been at about 80% leased and 20% owned. We're trying to ratchet that somewhere to around a 50-50 number, similar to the other roads. We think that's a reasonable number. We might take it down further, but it could be through new acquisition of new equipment rather than trying to convert existing leases. I don't know that there's a magic number right now for CapEx. That will be driven by the new business opportunities. And again, if it's crude, and they furnish all the cars, then we're just buying the locomotives. If that's something different, a steel train and we've got to buy the cars, then the CapEx will look different. So again, it's -- from our view right now, with the growth that we're enjoying, we don't see it as a problem, we see it as an opportunity. At some point, will it start to ratchet down? I'm sure it will. But where you'll see it first is in our basic network because we're, right now, at about 10%. I've talked about this in the past. 10% of our CapEx is maintenance. And as we've improved the system, you'll probably see that percentage drop down to 9% or 8%. But feeding -- fueling the growth is something we'll continue to do.

Tom, this is Mike Upchurch. Let me make one comment here. If you go back to 2007 levels, we have grown volumes 121% of that. So if you indexed it all back. The rest of the industry is at 97%. So we have clearly outgrown the industry, and that's supportive of the capital investments that we've made. Also think, if you look at the incremental margins that we generated on that and the incremental return on invested capital, it would clearly support the amount of capital that we've spent. And to Dave's point, the last thing we want to do is not be ready to capture that growth opportunity. So I think you ought to continue to expect us to be above those 17%, 18% industry levels. And at some point, if that growth opportunity isn't there, we'll peel the capital back, but I think we've clearly demonstrated we can grow volumes faster than the industry, improve margins better than the industry and improve return on invested capital better than the industry.

If I could just ask another question with regard to Mexico, is it a foregone conclusion that the Honda, Mazda plants are opening up or commencing operations, will be feeding all on the KCSM line? And if not, what do you sort of envision the mix of things, split between yourselves and Ferromex?

Well, it's different for each plant. We're not going to get it all. Certainly, we feel good about the share that we got. I'm not going to tell you exactly how much we got, but we feel good about the share that we got and we also feel good about the fact that we're going to be able to move some of these vehicles further on to our network in the U.S.

Our next question is coming from Jason Seidl from Cowen & Company.

Listen, if you have the growth, and you can keep posting good results, I think everyone wants you investing your network. So I'm not going to be too concerned with the level of CapEx going forward here. I do have some questions in terms of the impact on the really strong grain harvest. You guys said sort of record-ever numbers. If I go back, that implies well above of 70% growth number for the volume side. One, am I sort of looking in the right direction on this? And two, were the impacts on your yield, your average revenue per carload, and I'm going to assume a lot of this stuff is going to get exported?

I think this is one case, Jason, where looking in the rearview mirror might be helpful. If you go back to 2011, and I think that would be kind of a good benchmark for what we expect in the grain business for the next few quarters. 2011 -- first quarter of 2012 was unusually strong. I doubt -- I don't think we feel that we can necessarily hit that level. But 2011 was kind of the last really normal year for grain and for cross-border grain, so that's probably a good place to start. And yes, the average -- revenue per car and the yields on cross-border movements, particularly, when you look at the new Jacksonville facility -- Jacksonville, Illinois, which is kind of at the outermost reach of our network on the east side to Mexico City is a very, very, very nice long-haul for us. And the revenue per car in that business is going to be very attractive.

Okay, so we should see sequentially from 3Q, all things being equal, your -- tick up noticeably in grain?

Yes. What we saw in the third quarter, with the surge that we did get, was actually coming out of the Mississippi, Louisiana. So the revenue per car was lower than it normally would be when we're moving out of Kansas City, or Eastern Illinois -- Western Illinois.

Okay, great. My follow-up question is just a nitpick in modeling at this point. Mike, you said you're going to end up at about 35.5% tax rate. So that would imply that 4Q is going to see a tax rate go up noticeably from 3Q?

Well, I think the 3Q was 34.7%. So I don't know about noticeably.

Our next question is coming from Keith Schoonmaker from Morningstar.

I'm interested in your thoughts concerning Mexican energy reform, potential volume benefits. I know it's early and uncertain, but I bet you've thought about it a little bit. And second, I think, Dave, maybe it was you on one of these calls, who pointed out the apparent disparity between rig count, north and south of the border, maybe, as the crow flies looking down. But what did you expect under a significant shift in ownership rights maybe comparable to other nations?

Well, José has been patiently waiting down there in Mexico for a call, so I'm going to -- I don't want him to feel left out, so I'll let José take this one. I will comment first, though, before José answers. That rig count was really Pat, and it was a photo taken out of an airplane flying over the Rio Grande and looking down on the well sites on the U.S. side and no well sites on the Mexican side. So that's still the case, we still think it's a great opportunity. And José is keeping us posted on what the energy reform, what's happening and how it might affect us. But, José, go ahead, please. José L. Zozaya: Yes, thank you, Dave. Well, as you all know, Peña Nieto's party has proposed reform saying to help in pay mix to boost production. The proposal will of course maintain the state control over the company, but also allowed to enter into profit-sharing contracts with private companies. If the reforms are successful, and we think they will be -- just as we speak, the tax reform has been debating on the deputy's chamber last night. And part of that reform is that comes out today, which is expected from that chamber and both to the Senators' chamber is part of the deal is that, once approved, is that the Leftist party, will support the energy reform with the PRI. So there's a general consensus among Mexico's major parties, but many particulars needs to be worked out, there are some opposition of this still. We hope by 2014, Mexico can begin to move forward with some plans to expand its energy resources. The next few months, of course, are key and if we are going to see real progress, it is going to be in 2014 and 2015. Also, it is still early. We are optimistic that several reforms will result to opportunities to us to increase our business. And we do believe that we'll be growing opportunities to move frac sand, fuel oil, crude oil and LPG. I think those are the most important reference I can make at this moment.

Maybe a quick follow-up. I noticed in today's cash flow statement is the much larger purchased equipment under operating lease disclosed in your remark. It sounds like you're actively negotiating more of this. Based on progress so far, do you expect this to escalate, maybe be completed within a couple of years? And also, is the impact -- and I know there are a lot of moving lines here, but is the impact something like 200 basis points on OR, or is it smaller than that?

Well, as you can probably appreciate, the negotiations are very active and it remains to be seen how successful we are and able to acquire a lot of that equipment on a short-term basis. I think we've consistently said the gap that we have in the mix of leased to owned equipment is probably a 5-plus year timeframe for us. And we'll certainly keep people posted on the success that we have. We have -- over the last few years, purchased about $300 million off of lease and hopefully, we can continue to make that kind of a progress. But it's just very difficult whether lessors are interested in selling you the equipment, and then at the price that makes economic sense to us.

And on a go-forward basis, you'll see us much more inclined to purchase than lease. And that will move the needle over time.

Our final question today is coming from Anthony Gallo from Wells Fargo.

So back at Auto, you mentioned that you were able secure some of the U.S. moves to the Mexican auto production growth. Has all of that available business been awarded? And if not, can you speak to your network's advantages or disadvantages as it relates to winning, maybe, some additional business?

As far as I know, all of the expected volume has been awarded. If not -- that's not the case, necessarily, at Nissan. So the answer is, no, not all of it. Honda, Mazda, I think their awards are pretty complete. And again, keep in mind that we don't actually physically touch the Mazda plant. We have relied on an interchange there, but we did get a very nice award out of that. And the advantages of our network are, the way we orient the physical location of those plants to the markets that those vehicles really want to go in to, which is the Eastern United States and Canada, the big population centers over Laredo. That's the best route. And I think what the auto companies see is that our network, while we don't get to those places, Chicago, Atlanta, Charlotte, the East Coast, the Mid-Atlantic, we have very effective connections with carriers who do. And so they see that we can give them options over Kansas City, Houston, if you look at the Jackson Meridian, New Orleans, as kind of a gateway to those markets, we can give them options with other carriers to get to any of the markets in the eastern half of North America that they want to get to. So that gives us a definite advantage.

And then as a follow-up, does the use of any of these new auto railers have any influence on the profitability of this new business versus the existing book of auto business?

The revenue per unit on some of the AutoMax -- you're talking about the AutoMax and the other articulated vehicles, yes? There are some advantages. They're flexible. There are some security advantages in Mexico. It's a more difficult car to break into. And so there are some unique features and advantages and some of the carriers really like that car type.

The other part of your question, do we have to give up margin on those cars? The answer is, no.

We have reached the end of our Q&A session. I'd like to turn the floor back over to management for any further closing comments.

Okay. Thanks, everyone, on the call this morning. We appreciate the amount of interest that everyone is showing in KCS and it's TGIF, have a nice weekend. And we'll talk to you next quarter. Thank you.

Thanks, everyone. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We do thank you for your participation.