Union Pacific Corporation (UNP) Q2 2011 Earnings Report, Transcript and Summary

Greetings, and welcome to the Union Pacific Second Quarter 2011 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, and the slides for today's presentation are available on Union Pacific's website. It is now my pleasure to introduce your host, Mr. Jim Young, Chairman and CEO for Union Pacific. Thank you, Mr. Young, you may begin.

Good morning, everyone. Welcome to Union Pacific's Second Quarter Earnings Conference Call. With me in Omaha today are Jack Koraleski, Executive Vice President, Marketing and Sales; Lance Fritz, Executive Vice President, Operation; and Rob Knight, CFO. Union Pacific achieved another strong quarter despite continued weather challenges. We delivered an all-time quarterly earnings record of $1.59 per share, a 14% increase compared to 2010. In addition, we achieved a record second quarter in operating income, up 9% from last year. Cash from operations also hit a best-ever mark for the second quarter. The benefits of our diverse franchise really paid off this quarter. We saw volume gains in 5 of our 6 business groups with strong growth in Ag products and chemical shipments. As I mentioned, we continue to battle massive flooding in the Midwest. Lance will provide more details on this in few minutes. But I just want to comment on the tremendous job our team has done to protect the majority of our network while maintaining very strong customer service level. They really have accomplished an incredible feat. When we look at the financial impact of the flood, we estimate an earnings hit of about $0.04 a share, roughly $20 million of missed coal revenue and around $14 million in flood-related operating cost. Despite these challenges, we remain focused in delivering safe, efficient, high-quality service that guarantees -- that generates value for our customers. As Jack will show, these efforts were recognized with record customer satisfaction results. So with that, I'll turn it over to Jack.

Thanks, Jim, and good morning. Well Jim said, we've been on a great streak with our customer satisfaction scores over the past several quarters. And the second quarter of 2011 is no exception. Satisfaction for the quarter came in at 92, up 3 points from last year and topping our previous best set earlier this year. Along the way, we also set a new best-ever monthly mark receiving a score of 93 from our customers in April. That strong value proposition and a diverse business mix produced volume growth of 3% in the second quarter as the overall economy continued its slow improvement. We saw real strength in our Ag products and Chemical businesses, helping us to offset some of the impacts of flooding, which primarily affected our energy volumes. Core price improved 4.5% with each of the groups posting gains. Those price gains, along with increased fuel surcharge revenue and a couple of points positive mix from the strong growth in Ag and Chemical combined to produce a 13% increase in average revenue per car. The stronger volume and the improved average revenue per car growth rate revenue up 16% to a near record $4.6 billion. So let's take a look at the drivers of each of those businesses. Given the slight decline in our Intermodal volumes, I figured that's probably the one you're most interested in, so I thought we'd actually start there this morning. Our Intermodal revenue increased 13% of the 14% improvement and average revenue per unit was partially offset by a 1% decline in volume. The actual volume decline was driven by a contract loss in our International business, which was down 2% overall. Although international would have posted a small gain without that loss, the market slowed significantly as the quarter progressed. In fact, the most recent data showed softer import volumes in both May and June with West Coast ports seeing year-over-year decline while the East edged up a bit. That's a pretty sharp contrast to the solid growth numbers posted in the first 4 months. Uncertain signals on consumer demand has led to a more cautious inventory replenishment strategy, with inventories remaining at historically low levels relative to sales even as the retailers posted so much stronger sales year-over-year. Domestic Intermodal was flat versus last year's second quarter volume. The renegotiation of the last domestic Intermodal legacy contracts gave us the flexibility to take a totally new approach to the market. Early in 2011, we introduced our mutual commitment program where we're asking beneficial owners to commit off-peak volume in return for guaranteed price and box commitments during peak season. We wanted to ensure we got it right from the get-go, so our implementation wasn't quite as fast as what we had planned. This program represents a significant change for those customers, so we had to work really hard to build their understanding and also to assure them of our commitment to this new approach. Second factor for the flat volume was our continued focus on moving our Domestic Intermodal rates up to re-investable levels. Core price improvement in our Domestic Intermodal business was significantly higher than our 4.5% overall average for the quarter. This price improvement combined with the incremental fuel surcharge we now collect helped drive average revenue per unit up 16% for our -- Domestic Intermodal business, so we're making some pretty good progress here. Overall, we're offering a strong value proposition in this market, and we anticipate we'll see stronger growth as demand picks up here in the second half. Agricultural products volume grew 11%, which combined with a 9% improvement in average revenue per car to drive revenue growth of 22%. Export whole grain shipments increased 58% with strong worldwide demand driving a 59% increase in wheat exports and feed grain exports climbing 50% from 2010s relatively soft volumes. New business and increased production drove a 28% increase in import beer volumes, and export opportunities and solid margins for producers boosted ethanol shipments 9% while meals and oil volume were also up 9%. Our Automotive revenue climbed 14% as volume grew 4% and the average revenue per car increased 11%. The pace of recovery in the auto industry slowed a little in the second quarter, impacted both by the Japanese tsunami, and some degree of consumer hesitancy in the face of uncertain economic signals and higher gas prices. Despite those headwinds, U.S. vehicle sales still posted year-over-year gains. That translated into a 4% growth in our finished vehicle shipments, driven by the Detroit Three, and our parts shipments increased 2%. Chemical volume increased 11%, which combined with a 7% improvement in average revenue per car, drove revenue up 19%. Increased crude oil volume was again the primary driver of growth in our Petroleum Product segment, which increased 31% with asphalt and lubricants also continuing to show strength. With export potash shipments up 36% and strong seasonal demand for all nutrients, fertilizer grew 22%, and our industrial chemicals volume grew 6% reflecting a somewhat stronger economy. Despite the impact of the Mississippi River flooding early in the quarter and the Midwest flooding toward the end, energy posted a 14% increase in revenue, the result of an 11% improvement in average revenue per car and a 2% growth in volume. We're estimating that the floods reduced volume by about 14,000 cars or about 3 percentage points of volume growth during the quarter. Our Southern Powder River Basin tonnage increased 3%, again driven by new business to the Wisconsin utility. Colorado, Utah, which is competing in the Eastern market for both Eastern and SPRB coal and natural gas, saw tonnage decline 4%. This segment did see a boost from an improved international market with export volume to River terminals and West Coast ports up 700,000 tons. We often talk about the diversity of our business mix as being a franchise strength of Union Pacific. Nowhere is that more evident than in our Industrial Products business in the second quarter where volumes grew 4% even with no improvement in construction related markets. The combination of volume growth and an 11% improvement in average revenue per car drove revenue up 16%. Metallic mineral shipments increased 106% as our new iron ore unit train business from Utah to California for export to China ramped up. Energy demand and increased horizontal drilling continues to drive demand for frac sand, barites, and bentonite, resulting in a 34% growth in our nonmetallic mineral car loadings. Energy-related demand along with recovering auto industry is also boosting fuel and ferrous scrap shipments, which were up 5%. Highway conversions drove our 12% growth in paperboard, and in construction, our lumber posted a small gain, but cement and rock both declined for the quarter. We already talked about Intermodal so let me wrap up here with a look at what's ahead for the rest in 2011. The economy sent some mixed signals in the second quarter, but the general consensus is for stronger growth in the second half of the year and we actually share that view. While flood conditions continue unless the situation worsens unexpectedly, the volume impact should be pretty minimal for us. Here are some of the specific growth opportunities that we see for each of the 6 businesses. Our Ag products business faces a tough comp against last year's whole grain and meals volumes but ethanol growth should continue, and we expect to launch our new plant-to-rail service where we'll be moving both DDGS for transload and the containers for exports. Food and refrigerated shipments should also continue to grow. Auto sales are forecasted to strengthen, especially in the fourth quarter and the markets will get a boost from the continued recovery of the Japanese manufacturers. Along those lines, Toyota has told us that they're going to be back to 100% in North America by September, so that's some good news for us. Chemicals led our growth in the first half, and that solid performance should continue with shale development, and seasonal fertilizer demand, expected to lead the way. Energy is going to continue to benefit from the new Wisconsin Utility business, as well as the new coal-fired facility near Waco that started shipments earlier this month. Increased export interest is an encouraging trend especially for our Colorado, Utah business where output should increase as the mine that had been undergoing a longwall move is now returning back to full production. And the record heat that we're seeing together with the potential to make up some of the tons [ph] we missed due to the second quarter floodings should all be positives for us here in the second half. While housing and construction activity remain a question mark, energy-related demand and the ramp up of our iron ore export move, should lead for growth in Industrial Products. And in the Intermodal despite recent softening on the international side, we still anticipate a peak season, which should drive stronger Intermodal volume. The expectation is this year's peak will be somewhat compressed compared to last year when volumes were ramping up late in the second quarter. So overall, we've got a strong value proposition -- it's underpinned by excellent service, positions us to take advantage of these and other opportunities across our diverse portfolio. Expected growth in volume should continue with anticipated price gains to drive continued record revenue growth through the end of this year. And with that, I'm going to turn it over to Lance.

Thanks, Jack, and good morning. I'll start with our safety performance, which is the foundation of our operations. In the second quarter of 2011, we achieved another best-ever quarterly performance in employee safety. The continued maturation of our total safety culture and risk identification in mitigation processes, along with enhanced training drove the improvement. Our safety culture is especially important today as we've ramped up our hiring of new employees to cover both attrition and volume increases. We're also recalling employees back from furloughed status who haven't worked for us in more than 2 years. In terms of customer safety or derailments, we improved 10% to a record second quarter reportable incident rate. Investments in infrastructure, technology and training, all helped reduce the risk in our workplace. And despite increases in rail and highway traffic during the quarter, our crossing accident rate declined 14% versus 2010. We're turning to a long-term improvement trend. We continue to help communities address risky driver behavior and to close grade crossings. Overall, we're making great progress towards our ultimate goal of 0 incidents. Now, before reviewing our network performance, I want to spend a minute recapping how we're managing the flood here in the Midwest. A record amount of snow melt from the Rockies and the Northern Plains combined with June rainfall in the Midwest that averaged 200% to 300% above normal has generated massive flooding that we're currently seeing. Despite the widespread flooding, our team has done a tremendous job keeping tracks in service and managing around the disruptions. We successfully preserved our critical central quarter from North Platte through Omaha and into Iowa by raising tracks up to 5 feet, increasing drainage and building protected berm to prevent washouts. We are working with many federal, state and local agencies to keep this most critical rail line open. Unfortunately, we've lost our direct route between Omaha and Kansas City, and 1 of 2 routes between Kansas City and St. Louis. We are managing through these outages by employing surge resources and alternative routes, while helping customers with their contingency plans. In spite of the flooding, service levels and network performance for the second quarter remained relatively strong, demonstrating our resiliency and recoverability in the face of major weather disruptions. Our ability to handle both growing volumes and weather challenges is reflected on this chart. By applying the principles of the unified plan and utilizing our surge resources, we have sustained the network's service reliability and efficiency. As you can see, our network velocity remains strong averaging 26.1 miles per hour for the second quarter. However, we did see about a 1 mile per hour decline in June from May due to additional maintenance curfews, flood-related outages and congestion related to the flood. We continue to monitor network efficiency closely given all the route and schedule changes we've made due to the track outages. But the cost maintained excellent service as we battled the flood, resulted in mix productivity as indicated on the next slide. Gross ton miles per employee declined about 1% from 5.36 million to 5.32 million gross ton miles per employee. The addition of nearly 1,000 new hires in the training pipeline and increase in employees working on capital projects and the surge resources used to combat the flood completely offset our productivity initiatives in the quarter. We made this trade off to keep the network fluid, to keep trains moving efficiently and to build additional capacity for future growth. In the second half of 2011, we expect to return to the long-term trend of increasing GTMs per employee as we continue to implement productivity initiatives. Shown here are train sizes for our Intermodal and Manifest businesses, which improved again in the second quarter helping to offset some of the headwinds I mentioned earlier. Other productivity good news items in the quarter included leveraging first crew starts versus carload growth in our scheduled networks and improved fuel efficiency. Our service performance demonstrates the effectiveness of our resource and service planning as the growing value proposition that Union Pacific provides to our customers. Our service scorecard on Slide 18 illustrates UP's customer value proposition. As carloads grew 3%, our Service Delivery Index remained strong and improved from first quarter results. We absorbed the increased workload while maintaining solid customer service. Diving down a level, the local operating teams are building the fundamental elements of great service. One of those fundamental elements is captured by industry spot and poll, which set an all-time best quarterly record at 95%. And consistent with Jack's discussion on record customer satisfaction, our local customer satisfaction is also at an all-time best. This survey solicits feedback from customers the operating team interacts with daily at the shipping and receiving docks, where the accuracy and reliability of our industry crews is critical. So while the floods are certainly having an impact, we are largely overcoming the worst of it to provide customers with reliable, valuable service. The endgame is delivering the full potential of UP's franchise, translated into these deliverables. First, world-class safety results as we build a Total Safety Culture. Minimizing flood impacts through proactive measures and contingency planning, leveraging growth to the bottom line with network productivity and growing the value proposition for our customers and positioning for growth as we provide excellent service. So going forward, the key for the operating team is agility in delivering on UP's value proposition. We'll continue to work to meet customer expectations, while enhancing shareholder returns regardless of the circumstances. With that, I'll turn it over to Rob for the financial review.

Thanks, Lance, and good morning. Let's start by summarizing our second quarter results. Operating revenue grew 16% to a record $4.9 billion on the strength of core pricing gains, fuel surcharge recoveries and volume growth. Operating expense totaled $3.5 billion, increasing 19% or $563 million compared to the second quarter of 2010. Higher fuel prices accounted for roughly half of this increase. Operating income totaled $1.4 billion, a 9% increase and a second quarter record for us. Other income totaled $26 million in the second quarter, $7 million higher compared to last year. Quarterly interest expense declined 3% versus second quarter 2010 to $148 million driven by lower average debt levels. Second quarter income tax expense increased to $485 million, higher pretax earnings drove this increase. Net income totaled $785 million, increasing 10% compared to 2010. The outstanding share balance declined 3% versus last year reflecting our share repurchase activities. These results drove an all-time quarterly record in the earnings-per-share of $1.59, a 14% increase versus last year. Turning now to our top line. We achieved 16% freight revenue growth to a second quarter record of $4.6 billion. This slide provides a walk across of the second quarter growth drivers. Second quarter car loadings were up 3%. We also saw a positive mix impact, driven by strong growth and higher average revenue per car moves. We saw price improvement of 4.5% in the second quarter. Core pricing gains were driven by solid demand, our value proposition and RCAF fuel escalators. As we have stated before, the majority of business in our legacy portfolio that we will compete for and reprice this year does not come up for renewal until mid-fourth quarter of this year. Fuel surcharge revenue added 6% to the top line, reflecting higher fuel prices in the second quarter compared to 2010. If you look at our incremental margin for the second quarter after adjusting for higher fuel prices and the flood impact, revenues were up 10.5%, while costs grew 9.5%. That relationship equates to an incremental margin of about 36%. As we noted in April, we've taken the necessary steps to prepare for future volume growth in the second half of this year. That being said, we believe 36% incremental margins will be the low mark for the year. As you know, our long-term guidance includes an operating ratio of 65% to 67% by 2015. In order to achieve this, we are focusing on incremental margins in the neighborhood of about 50% over the next several years. Of course, this depends upon volume level and fuel prices. Now let's turn to expenses. Slide 24, summarizes our year-over-year increases in operating expense by category. As I mentioned, higher fuel prices contributed to roughly half of the $563 million increase in expense. Other more normalized year-over-year increases include: Inflationary cost and volume-related expenses, and as we saw increases in casualty expense, TE&Y training costs and flood-related expenses. With that, let's spend a minute and walk through each of these categories. Second quarter fuel expense totaled $904 million, increasing $296 million compared to last year. The average diesel fuel price, which increased 44% year-over-year was the biggest driver of this quarterly change. Two factors drove the increase. First, the average barrel price of $103 rose 32% compared to last year. And secondly, conversion spread, which cover the cost to convert crude oil to diesel fuel, more than doubled to an average of $27 per barrel in the second quarter compared to last year. Although our fuel surcharge mechanisms enabled us to recover the majority of the higher fuel prices, the resulting increase in expense and revenue had a negative impact on our operating ratio. The effect was a 2-point increase in our operating ratio and $0.02 reduction in our earnings per share compared to the second quarter of 2010. Fuel expense was also higher as a result of a 5% increase in gross ton miles. A portion of these expenses were offset by improvements in our consumption rate. Our fuel conservation efforts produced a 2% savings in the quarter. Slide 26, summarizes second quarter expenses for compensation and benefits. Breaking down the year-over-year change, about half of the increase in expense can be attributed to inflationary pressures that we have discussed with you and we did it back in April, health and welfare, unemployment taxes, wage increases and pension costs. The remainder was driven by volume growth, higher training costs and expenses associated with flood-related activities. Productivity was somewhat masked by additional resources needed for rerouting and curfews caused by the flooding as Lance just described. Training costs were up $26 million in the quarter, as new employees were hired for expected second half 2011 attrition and volume growth. Slide 27, takes a closer look at the change in our workforce levels. Workforce levels increased 6% in the second quarter compared to 2010. Higher volumes in the quarter drove 2.5% increase. We had more employees in the training pipeline during the quarter, driving another 2.5% increase. In addition, there were more individuals working on capital projects including Positive Train Control, which added another 1%. That's a net add of about 2,400 employees. Looking at our full year projections, we would expect our workforce to be up around 1,500 employees, of course, this is dependent upon volumes. Walking through the numbers. We have expected attrition of roughly 4,000 employees this year. We will hire around 4,500 new employees, and we'll continue to recall our furloughed employees, which should add another 1,000 or so to our workforce by yearend. That being said, these projections are dependent upon volume assumptions, and we will adjust accordingly. Now turning to our other expense categories. Other expenses came in at $196 million. We beat our guidance of $225 million primarily due to lower-than-expected personal injury expense reflecting favorable results from our actuarial study. Our continued safety gains drove this positive experience. Versus 2010, the other expense category was up $74 million. Although lower than expected, personal injury and other casualty-related costs were still higher in the quarter compared to last year. Going forward, we still expect continued safety gains. Other cost pressures including increased operating taxes also drove expenses up in the quarter versus 2010. Barring any unusual items, we expect the other expense category to end up around $215 million to $225 million a quarter for the balance of the year. We remain committed in our efforts to offset cost pressures. Purchased services and materials expense increased 9% or $44 million to $516 million. The biggest driver of the increase was greater use of contract services associated with higher volumes and flood prevention efforts. Crew lodging and transportation costs also increased with the growth in volume levels. Locomotive and freight car maintenance costs were also up year-over-year, as we returned stored assets to active service, not only to cover volume growth, but also as additional resources to help mitigate the impact of rerouting caused by the flooding. In total, we incurred $14 million of flood-related expenses, $10 million is reflected in the purchased services line and the remaining $4 million hit our labor expense line. Slide 29, summarizes second quarter expenses for the remaining 2 categories. Depreciation expense increased 9% or $33 million to $401 million, which is in line with the previous guidance that we gave. Increased capital spending and higher depreciation associated with hauling more gross ton miles drove this increase. Looking at the second half of 2011, we expect depreciation expense to increase at about the same rate on a year-over-year basis that we saw in the first half of this year. Second quarter equipment and other rent expense totaled $283 million, flat with last year. Increases in other rental expenses were offset by lower freight car and locomotive lease expenses. Bringing both the revenue and expense sides together, Union Pacific's operating ratio illustrate the substantial improvements in profitability that we achieved over the last several years. On a reported basis, our operating ratio was 71.3% for the second quarter of 2011. Ongoing productivity efforts, core pricing gains and volume growth all contributed to this mark. Higher fuel prices continue to put pressure on our operating ratio creating a 2-point headwind in the second quarter and for the first half of this year compared to 2010. If fuel prices stay at current levels, and with 6 months already behind us, it will be difficult to make full year improvement versus last year's record of 70.6%. However, if you adjust for fuel prices, we fully expect to see real improvement in this year's core operating ratio versus last year's record mark. Union Pacific's profitability in the second quarter of 2011 also drove record free cash flow after dividends, growth in cash from operations more than offset increased capital spending and higher dividend payments. Cash dividends paid in the year-to-date period of 2011 were up 38% from 2010's level. Similar to the first quarter, bonus depreciation contributed positively to cash flows in both years. Union Pacific's balance sheet continues to be in excellent shape consistent with the goal of maintaining an investment-grade credit rating. At the end of the second quarter, the adjusted debt-to-cap ratio was 40.9%. There's some timing in this entry year number and we'd expect that 2011 year end ratio to be slightly higher. Our performance continues to generate strong cash flow, and we've returned that to our shareholders in the form of dividends and share repurchases. In May, we increased our second quarter dividend by 25%. This was a significant step toward achieving our targeted payout ratio of 30%. During the second quarter, we bought back 3.6 million shares, totaling $360 million. These shares were purchased under our new authorization program of 40 million shares. Dividend growth and opportunistic share repurchases continue to be key components of our balanced approach to cash allocation for the long-term benefit of our shareholders. Looking ahead, we see continued opportunities to grow and improve our profitability. As Jack discussed, we're focusing on continued volume growth in the second half of 2011. Of course, this assumes that the economy cooperates. We remain committed to achieving real pricing gains in 2011, driven by the increased value of our service, solid market demand and the added benefit of competing for and repricing our legacy business later this year. As we look at the second half of the year, the combination of stronger revenue growth our ongoing productivity efforts and current resource investments should produce record earnings, allowing us to reward our shareholders with even greater returns. With that, I'd turn it back to Jim.

Thanks, Rob. With the first half behind us, we delivered record financials. Looking into the second half, we expect stronger performance despite some economic uncertainties and ongoing flood challenges. Union Pacific's strong value proposition, our diverse franchise and record service performance, all position us to deliver volume gain, price, and increased productivity over the balance of the year. These efforts will translate into increased value for our customers and stronger cash flows and financial returns for our shareholders. So with that, let's open it up for your questions.

[Operator Instructions] Our first question is from Justin Yagerman of Deutsche Bank.

I was curious -- your outlook for the second half of the year sounded fairly solid from a volume standpoint despite the challenges that have been facing the economy. Can you give us a sense of what your customers are telling you especially on the Intermodal side? Curious what your thoughts are from a peak season standpoint? And maybe if you could go into a little bit of what happened on the international customer side, and how that will play out this peak season for you guys?

Sure. Overall, our customer base is expecting that we still are going to have a peak season. And overall, they're saying it's probably going to be more compressed than what we've normally seen start a little later, more in the August timeframe instead of July. And actually, it could be higher in intensity given the shorter duration of it. I think combination of higher fuel prices as we got into the second quarter here and a lot of uncertainty about what's going on with the debt ceiling and what that impact that'll have on the economy on taxes and things like that has resulted in consumers kind of pulling in a bit. And I think basically a lot of retailers are going to wait and see that resolution before we start shipping before the holiday season. So we're not -- we're kind of staying with what our customers are saying, which is, it's going to be more compressed. It's going to be stronger in intensity, and we're prepared for that. We feel good about that. In terms of the international contract, Justin we're not going to really get into details of that. It was not surprising for us. It is obviously disappointing; you always hate to lose some business. But we're good, and we're moving on.

Hey, Justin. I'd tell you. When you think about the second half, there's probably 4 things when you're saying what's the difference second half versus first, just as Jack said. You will have a fall harvest, and even though you've got some massive flooding out here. It's pretty minor in terms of the harvest. And right now, when you look at rain and heat, we should have pretty good harvest. Our coal business should be stronger second half versus first year. Obviously the big part of the flood's behind us. But if you look at the heating days, and you all should be experiencing the weather, we think we've got some real potential on growth there. As Jack said, we do expect a peak season. Christmas will come. It maybe a little bit tighter that's out here. But again, that is a potential upside. And another one, that I think gets missed is, auto production should be stronger, not only new model year coming in, but you have the Japan impact from first -- second quarter that we should say it's still a bit stronger, so I think if you look at the last 5, 6 years, we've always had stronger second half versus first. The only difference was when 2008 and the recession hit. So we -- I'm pretty confident, you're going to see stronger volumes through second half.

Thanks, Jim. And, I guess, for Rob, you've spoken earlier this year to the fact that you thought first quarter core pricing was going to be the trough for the year. This obviously came in in-line with where first quarter was. Curious, from an outlook standpoint, if you still have confidence that the second half should be higher from a core pricing standpoint and what gives you that confidence as you look out?

Yes, Justin. This is Jim. Our pricing is that, it was very good in the quarter. And I want you to think about this here. Our areas that we have had the biggest upside from legacy in this business, which is coal and Intermodal had this lowest growth. So when you look at it, we had some negative mix in our business in second quarter. And I'm very confident in our pricing going forward. We're adding a lot of value. We're going to -- when you look at -- again this will be a punch when we look at demand the second half. If demand gets stronger than what we expect, we'll see higher pricing. But I feel good about our pricing plan.

Our next question is from the line of Jon Langenfeld Robert W. Baird. Jon Langenfeld - Robert W. Baird & Co. Incorporated: On the Intermodal -- Domestic Intermodal side. Can you talk through -- you talked about the strategy of getting full year commitments from the shippers. How much of it is that versus -- we're simply raising our rates to a more market prices and therefore you have some shippers that have sought other alternatives whether be in or whether back to the trough because the rates were unsustainably low from many years.

John, that's always really hard to discern which is which, because they kind of go hand and glove. The mutual commitment program actually has price increases associated with it as well. So it's a change. It's something very different than anything we've ever done before. A lot of customers are testing our commitment and I resolve to follow through with that. I would guess -- that affects probably 65% of my Domestic Intermodal business. I think that was probably a somewhat bigger factor than the pricing. Jon Langenfeld - Robert W. Baird & Co. Incorporated: And ultimately, is this something you get through 1 cycle here, 1 season and you show the commitment on the back-end and then they're comfortable with it. And by the time you get into 2012, it should be more normalized growth relative to the market on the domestic side?

Yes, that's my fondest hope. Jon, as we think about it, getting through this first year is critical. Last year, we disappointed customers. We didn't have enough boxes. They're really watching us very carefully in terms of when we make the commitment for the boxes, will they actually be there. Lance and his team are delivering on that. We're going to be there without a doubt. And when they see that we really can do what we're promising and the commitment we're making, I think 2012 will be a much better opportunity. We'll be more in line with the market.

Our next question is from the line of Ken Hoexter with Merrill Lynch.

If I could just dig into the -- that shift on the Intermodal. Maybe, Jack, can you just kind of roll that out a little bit more. What are you doing to smooth the demand by the pricing shifts? Can you kind of just go over that a little bit deeper.

Sure, Ken. What we're asking customers -- the beneficial cargo owners to do is to make a commitment for off-peak volume. And whatever they are willing to commit to us in the off-peak period, we will make a commitment to them to protect in terms of box availability up to 110% of that volume during peak. So the more they commit to us during the off-peak, the greater they'll have a commitment of a fixed box availability for them during the peak season. And... John Mims - BB&T Capital Markets: So it's a capacity guarantee not -- is the price built into that?

Yes, there is a price built into that, and the price is protected up to the 110%. If they go over the 110%, then it starts to change.

Our next question is from the line of Bill Greene with Morgan Stanley.

When we think about the key pillars or real pieces [ph], we had pricing volume productivity, and now here in 2011 obviously, we had the flooding challenges and what not. But there's obviously questions at the macro level on the volume growth rate. And the cost inflation is starting to kick up. So you think it's fair to sort of say that the opportunity from those buckets is more diminished, and now it's really kind of hinges on pricing from here on out?

Well, Bill, I don't think so. You've got to -- obviously, the economy is still relatively weak. So again, when we went into the year we said slow growth. And that's pretty much what we're seeing. We're actually getting a little bit different in the second quarter than we expected. But you will level -- we will leverage growth going forward here. So I'm not quite certain what your question is. Again, sure, I'd like to have a hot economy that's out here, but we will see very good leverage second half. The pricing stories there and in fact, I think, again, if the economy picks up strong, you've got upside with the value proposition. In the productivity side, we obviously are resourced for more volume right now. When you look at the second quarter results, it should be our low point this second quarter in terms of efficiency, in terms of the amount of resources we have at second quarter. But I would tell you this, if the volume doesn't materialize, we will respond. Keep in mind, we're going to lose 4,000 employees this year in terms of attrition. And as we showed in the last couple of years, you get a downturn in the economy here. We can take some cost off it. All 3 of them are going to be necessary for us to get to our long-term commitment on the operating ratio.

Yes. So there's a bit of a timing mismatch here in terms of the resources or in the volumes weren't there. But assuming that that's all right, then you feel pretty good about your productivity.

Absolutely, Bill. And again, it's difficult to see the economy going forward here today. You do have issues. And then -- we'd asked about the question about how our customers are feeling. I mean there is an uncertainty, whether it's customers or employees out here when they read in the media that because of issues in D.C., we're going to have a meltdown in this country. And my concern is that people stop spending. That's out here. We're not seeing that yet. And I do believe, again, we'll see volume growth the second half of the year. But there's probably more uncertainty right now. There's no question. There's more uncertainty right now in the economy today than when we came in at the start of the year.

That's fair. Just one clarification on pricing. Once we're through the legacy repricing, how will the contracts work? What's the average age where we think of we can touch this percent of the business each year on pricing once we're sort of through all that?

Yes. Bill, overall, we have probably about 40% to 45% of our business tied up in multiyear contracts. So some portion of that will come up every year because obviously, those are staggered over different time periods. The remaining 55% to 60% of our business is either in tariff or in one-year deals. And that pricing comes up on an ongoing basis. So you guys are always asking us the question how much of our business is locked-in -- regardless of when you ask that question, it's usually about 70%. And those deals are coming up, either the one-year deals, the tariff deals or the renegotiation of contract rates as we go through the year.

And are they staggered in a way where they're heavy in the single quarter or it's just normal throughout the year?

Probably just because of historical practice, many of them kind of expire and renew at the end of the year. But over time, that's kind of been changing. And it really is dependent upon the business, the customers' views. In a lot of cases, if you look at, for instance, the Intermodal world where the commitments are really made in the May, June timeframe, that's kind of shifted away from year-end contract renegotiations. So it's evolving over time.

Our next question is coming from the line of Tom Wadewitz of JPMorgan. Thomas Wadewitz - JP Morgan Chase & Co: Let's see. I'll start with a question on the broader coal topic. I'm just trying to figure out how to look at coal volumes in second half. It seems like you've got a number of moving parts. When do you think that the flooding impact will abate? And we'll see a more normal run rate, just in terms of being able to run the railroad and handle the coal? And then how would you anticipate that what would appear to be a pretty material decline in stockpiles, how do think that affects your potential? Does that mean you can grow coal in fourth quarter 5%? Or -- I'm just trying to get a sense of how to model because it's tricky given the kind of various weather effects.

Okay, Lance, why don't you take the comment on operations.

Sure. Yes, Tom, as we're looking forward on the floods, we could be fortunate and start returning to a normal railroad sometime in early August or a more pessimistic view could be late August and into September. It's really very dependent on what happens with rain event in this basin that's draining into Missouri River. But right now, I would say on balance, we'll probably be returning to a normal railroad sometime in August.

Okay, Lance. Tom, the only caveat here though, we do have the network more stable. I mean, there are 2 pieces of the flood it's when you've got it and you've got your lines out, and we're not moving anything. Lance and his team have done a great job to where it's stable. That means we still have out-of-route moves that will impact your velocity. But right now, it's pretty stable. If you look at our coal loadings for the last several days, we're starting to see some pickup here. So I think operationally, again, being stable. We can handle the volume if it's there. Jack, you want to comment on the market?

Yes, Tom. I think in the second quarter, I would have been up 5% without the floods anyway. So to say that we'll be at 5% in the second half, it looks to me 5% is a conservative number. I actually think we can do better than that. Thomas Wadewitz - JP Morgan Chase & Co: Okay. Great. That's helpful. And then the follow-up question. When we look at 2012, I think there's a recognition that you've got this big chunk of legacy business, $750 million in fourth quarter this year and then $300 million next year, so very large potential impact from legacy. And the different scenarios, you can model, you can say while you typically would step it all up at once and get a large impact or I think there've been cases where you said, "Well the customer doesn't want to take the step-up all at once, and so we'll ramp it over a couple of years." And obviously, that makes a material difference on how you model the legacy impact. So can you provide any framework for what's kind of a more likely outcome on that legacy book? Do you get a lot of it at once? Or is it kind of more natural to get that step-up over a couple of years?

Tom, at the end of the day here, there are some cases where it might be stepped up. But even in those cases, there was a substantial increase in year one. I mean, some of these contracts are so far off of market and basic economics that you can't afford to walk in without a pretty big increase. So 2012 I think has very good potential for us. And the issue of whether it's walked up is really minimal.

Our next question is coming from the line of Walter Spracklin of RBC Capital Markets.

So the first question is essentially on the pricing side. You've always talked about real pricing gains in excess of inflation and one of your competitors, obviously, came out with a third-party report saying that they were looking at real inflation trending at 4.6%. How do you look at that? When you look at your own business, when we listen to you saying inflation plus, should we wrap our head around inflation of 4.5%? Or -- I had in the back of my mind something lower but perhaps, you can weigh in on your thoughts there.

Rob, you want to take that?

Yes, when we look at that, at least here in the midterm, Walter, we're looking at more in the 3.5% kind of range for all inflation.

Okay, perfect. Okay, and just a clarification, you mentioned a stronger back half, but obviously, and you also mentioned, you're always stronger in the back half. Do you mean that you're going to do better in the back half compared to what -- that improvement year-over-year that you've done on a seasonal basis in past?

I'm not certain...

Just to clarify there. You've always had a better back half. Saying that you're going to have a better back half, I'm just wondering is it going to be better than normal, if you're to look at a seasonal, through the year? Or is it just, yes, we expected to do better like we always do better?

Yes, part of it is we expect to do better, like we always do better. But what we've been saying is that, recall what we've been doing in both the first and the second quarter, is preparing for the anticipated growth in volumes in the beginning of the third quarter. And so when we've been saying that, we pretty much admit sequentially. But year-over-year, we expect to see volume growth. We expect to see gains on most of our measures. So it's both sequential and year-over-year.

Now, Walter, the only caveat that you'll run into there and I'm not -- we are always dealing with weather in this business, in fact hurricane season is now starting. We have been hit pretty hard here in the first half when you look at the weather. And that's a wildcard for us, second half. So assuming maybe a normal timeline here and whatever that might mean, I'd say there's a little bit upside there. The real lever to me on second half is going to be what happens with the economy. Really consumer demand will be the big or the main factor.

Could that be offset at all by some push quarter [ph] volumes? Or where those volumes that you lost, lost for good in the first half?

The coal clearly is there for us over the next 6 months. It's whether the whole chain -- you've got a couple of different drivers of demand here. You've got what's happening with stockpiles as we've seen from the flood. So there should be some potential there. The heating season right now is when you look at what's going on with weather that should be a positive. It's really a question whether the whole logistics chain can handle it. But we clearly will see more coal volumes second half than we had first half. No question in my mind.

Our next question is from the line of Chris Wetherbee of Citigroup.

Maybe one for Rob on headcount. You mentioned that you should expect I think in the neighborhood of about 1,500 year-over-year employee growth. When you think about the attrition, do you see that more -- it seems like that's more back half weighted. Do you think you'll start to see some of that benefit in the third quarter? Or does it stretch out a little bit to fourth quarter? Just trying to get some sense of the sequential run rate of that employee count going forward.

Yes, a couple of points I wanted to make there is, as you know, we were up about 2,400 in the second quarter. And the point is, again depending on volumes, we expect that to come down to only being up, call it, 1,500 or so by the time the year ends -- finishes out. We have attrition throughout the year. There's probably a slight increase in the attrition rate in the third and fourth quarters from the first half. But we see attrition throughout the year. And we are still believing, at this point, that by the time the full year wraps up, that we'll have around 4,000 folks to train.

Okay. So that is basically balanced would be your view in third and fourth quarter, depending obviously on the total volumes?

Yes.

Okay, that's helpful. And then follow-up on the Intermodal, the commitment from your customers. I guess, Jack, when you think about peak season being a little bit compressed here, I guess, do you feel like some customers are maybe playing a little bit of chicken depending on how they feel about the peak season and whether or not they want to provide a commitment? And I guess, if the peak season turns out to be a little bit less than expected, does that mean that maybe you push off another year or so the full implementation or getting through this process? I know you commented on that a little bit earlier but just your thoughts around that.

If we have a compressed peak with kind of a higher, more intense center, that will work quite well for us. And we'll prove to our customers that we will stand by those commitments, deliver the boxes, and they'll be protected. And I think that sets the stage well for us. If peak is a little softer than that, I think they'll still see our performance, and I still think they'll see the first year of this program as being a plus. And we'll be fine going forward.

Chris, I think one of the things we want to be careful on is coming out of a quarter here where our volume is flat. When you think long-term Intermodal, there's no question on my mind that Intermodal offers us the highest growth rate in the future. We are going to have some aberrations. We're doing some things in the market that's new to us. But the value propositions there, we see customers today that are managing their inventory. I mean the whole rail industry, when you look at Intermodal's providing great service, that changes customers' mindset and how they think about inventories and may push it tighter. But we're backing it up with our investments. I really do see the Intermodal -- really all of our businesses have growth opportunity but Intermodal has the highest potential for us.

Our next question is coming from the line of Scott Malat of Goldman Sachs.

I think I was a little surprised by was just the fuel consumption rate improvement just given the flooding. Was that affected by the flooding? And then what can you expect out of fuel efficiency going forward?

Lance?

Yes, absolutely. Not surprising to us, Scott. There's a number of underlying initiatives that are driving that fuel efficiency. We've got Fuel Masters Program, which gets the engineers engaged in managing their trains so that they consume less fuel. Our training tools, we're using the technology of our simulators to help engineers understand the perfect run so that they can manage the train for fuel consumption purposes. As we add new locomotives, that automatically improves sea rate as we more deeply penetrate DPU, that's a sea rate improvement. So the go-forward look is that those continued programs plus new ones that we're implementing like top-of-rail treatments are going to continue to drive improved sea rate.

Did the flooding have an impact this quarter so the run rate's even better than this?

Flooding would have some impact. When we're putting trains on reroutes, that might have an impact. But I would say, largely speaking, you set aside the fact that the flood is impacting dwell and delay, which is deleterious to sea rate, I bet that's rounding.

Okay, thanks. And then the other thing I was looking for is just on petroleum products, the 31% growth. Can you talk about that a little bit? What are you seeing out there in terms of opportunities for moving oil?

Jack?

Last year, Scott, we moved about $10 million of petroleum products overall. We'll probably quadruple that amount this year in terms of moving from the Bakken down to St. James and elsewhere. We're seeing just a lot of interest overall. One of the unique things that rail gives to customers is the opportunity to go to various places and to play to the extent they can -- the market advantages for themselves. So we see a lot of interest in that. The infrastructure is being built-out by developers. We're focusing exclusively on our own rail infrastructure to support it. And everything that we see, even as pipelines develop, tells us there's going to be a continued opportunity for rail in this marketplace going forward for a long time.

And then you said that they're ramping up, can you talk about the capacity, what they have ramped up to this year?

I don't have a clear picture of entirely all that is in terms of all the things that they've done. But new facilities certainly are on the development side at this point in time. So there's additional capacity coming onstream that we can handle more and more business. And now we're looking not only at the Bakken, but at the Eagle Ford and some of the other shale developments that are taking place.

That's helpful.

Scott, I said $10 million, that's 10,000 moves. And it was 4,000 moves, 16,000 is what we're ramping up to. But I do think actually it will be closer to $40 million compared to the $10 million also.

Our next question is from the line of John Larkin with Stifel, Nicolaus. John Larkin - Stifel, Nicolaus & Co., Inc.: Over the last few months, we've seen a couple of cases where the Eastern railroads, particularly Norfolk Southern, has been using the strategy of overhauling locomotives at close to the end of their useful life as an alternative to buying new ones. And that seems to be a way to save somewhere on the order of $1 million a copy. Have you done that? Are you doing that? Are you looking into it? Is that a viable alternative for Union Pacific?

Yes, I'll let Lance handle that. But we've had a strategy for some time in terms of our overhaul project here in terms of trying to get to one overall versus 2 on a cycle. But go ahead, Lance.

Yes, that's exactly right. Jim is exactly right. For some time and as we look forward, part of our locomotive strategy -- asset strategy, overall, is to overhaul locomotives. Our game plan is to try to make that overhaul happen once in the full lifetime of our use of the locomotive. And we use some fairly sophisticated, statistical modeling and maintenance modeling to figure that out. But we're overhauling locomotives this year as part of our normal strategy. We did it in previous years, and we'll do it in the future years as well.

The key, which you have to think about through here, John, is with fuel at $3.40 a gallon, if you start looking at a locomotive that's pushing that 15-year age limit, you do an overhaul, but you better make certain you understand fuel efficiency, one, and emissions, two, and reliability, three, going forward. So all that comes into the equation there. But we've been doing this for a long time. John Larkin - Stifel, Nicolaus & Co., Inc.: Got it. And then I was intrigued by Jack's comment that you recently started up an iron ore exporting unit train, it sounded like. Could you give us a little more color that? And then does that have any growth opportunities embedded in it? And are there other bulk materials that perhaps could be exported as well that you perhaps could play a role in handling?

Sure. The iron ore move, it originates in Utah. We take it to Richmond, California where it's loaded on the vessels for delivery to Asia, to China. And it's a growing opportunity. I mean, there are lots of opportunities out there to move iron ore and any steel-related products over to China at this point in time. Probably one of the bigger hurdles for us is port capacity, kind of like the export coal situation as well. But we're continuing to work with customers and exploring ports, not only domestically within the U.S., but also in Mexico because the demand is growing for us. And then so that's kind of on the steel side. Our DDGS, our port-to-rail facility at Yuma, California, it's scheduled to start in September. We hope we'll bring that online. I think we're through all of our permitting and got all of the things done that we need to do. So starting in September, we'll start moving unit trains of DDGS to Yuma, California. We'll bring boxes. We will either intercept boxes on the way to the port or actually just bring boxes out of the port -- containers and stuff them and then take them back for delivery from there. So a lot of export opportunities actually overall.

Our next question is coming from the line of Chris Ceraso of Credit Suisse Group. Christopher Ceraso - Crédit Suisse AG: I have one follow-up question on the previous one about headcount. If I'm understanding you right, are we going to have a net decline in the number of heads in the second half relative to the first half to get to that plus 1,500 for the year.

Chris, this is Rob. What we're saying is that year-over-year, the gap will be narrower than it was in second quarter and the big driver of that, by the way, is what happened last year. If you recall last year, basically in the first half, we were doing -- had very few people in the training pipeline. And in the back half of last year, that number ramped up.

Chris, keep in mind, that also, as Rob said, it's a function of volume. Christopher Ceraso - Crédit Suisse AG: Okay. And then you talked about the incremental margin was 36%. If you strip out fuel and the flood effect in the second quarter, longer term, you target is in the 50s. Is it fair to assume then in the second half of this year, let's say fuel goes sideways, that we can be in the 40s?

Chris, it's Rob. Yes, that's possible. Again, there are a lot of factors in there. But you're right. If fuel goes sideways, that's a plus. And as I pointed out, we would expect that, that 36% will be the low mark for the year. So a lot of moving parts there. But we certainly expect to improve upon that.

Yes, you will see improved margins second half. Christopher Ceraso - Crédit Suisse AG: And just one quick housekeeping, what was the core price x the RCAF adjustment?

The RCAF -- this is Rob. The RCAF fuel component in the 4.5 was roughly 1%.

Our next question is from the line of Scott Group of Wolfe Trahan.

Just real quick, Rob, can you quantify the actuarial gain in the quarter?

Personal injury was about, well, little over $20 million, which, as I pointed out, was lower. Substantially lower than last year's second quarter actuarial number, which is, so again, the complete story on that, great safety performance is going to continue. We are real proud of what we've accomplished. But year-over-year, that expense line was up because last year's second quarter accrual adjustment was substantially higher.

Okay, that's helpful. Just at a higher level, fuel was lower today than it was last quarter, but the comments on margins are a bit more cautious. I'm just trying to understand that, is that really just the weather impact? Or is this cost inflation more than you originally thought? Is it maybe changes in your assumptions on volume or pricing? Just any color there would be helpful and just what's driving the more cautious commentary on margins.

Scott, are you talking about second half expectations or...

Well, I guess, last quarter, the commentary was we'd see full year margin improvement, and now it's margin improvement x fuel.

So on the operating ratio?

Yes.

Yes, Scott, it really is just the math, I mean, if you look at the impact of fuel even if you're recovering most of it, and we're not at a point where we're recovering all of it in the marketplace by the way, but even if you are doing a substantially higher job of recovering the rising fuel price in the marketplace, just the math on your operating ratio is a headwind. And the first half of the year, that headwind was about 2 points. So to your points, even if fuel stays sideways, but still high, that will put a headwind on our overall operating ratio improvement.

I think that now, from where we were at last quarter, our expectations now is fuel is going to be higher than what we maybe had assumed a quarter ago. But it's anybody's guess with the volatility.

Okay, that's helpful. And just the last question is on Intermodal. I understand that the contract loss, but if I look at your volumes, they're flattish. Your western competitor's up 10. I'm guessing there's more than just a contract loss driving that spread. Any additional color you can give would be great on why you are seeing kind of flattish Intermodal volumes, particularly on the domestic side, given the strength we're seeing from J.B. Hunt and Hub.

Yes, well again, Scott, as I explained, there's actually 2 components to that. The first is our push to get pricing back up to reinvestable levels in the second. And I think, what's probably a somewhat bigger factor, is our new mutual commitment program that we're asking all beneficial cargo owners to commit to volume levels during the off-peak season in order for us to offer them and protect them service and pricing levels in the peak season. And that's a change. That's a fairly significant change from anything they've seen from Union Pacific before. And for some of them, I think they were more comfortable taking an alternative that they were familiar with and waiting to see just how that played itself out.

Scott, we need to let this play a cycle, which is this year, to see how this will work for us.

Our next question is from the line of Matt Troy of Susquehanna Financial.

I wanted to return to the topic of peak shipping season. It does look like you data [ph] coming across multiple modes. It's coming in a little bit light. We're hearing the same thing from everyone, everyone is crossing their fingers and hoping that there's a delay in dramatic peak. I'm just wondering, one, since it seems to be fairly broad based, could you provide any color? Are we talking about any pocket of retail or low-end [ph] technologies? Is it localized to a particular part of the economy? And secondly, what are your customers telling you about inventory levels? I mean, are they at where they need to be on the Intermodal side, of the Intermodal feeds such that we could go through back to school actually without that pickup?

Matt, it's pretty hard. If you just look at the overall sales to the inventory ratios right now, they are as low as they've been. I mean they are at 30-year lows and have stayed there consistently. And so there is not a lot of in -- and our customers will tell us. They are not building inventories right at the moment. They are being cautious. They are kind of waiting to see what's going to unfold here with the economy. But certainly, when you look at the inventory levels that retailers are holding, and as I've said earlier, even compared to the fact that their sales were up a bit, there's not much room in the supply chain. If there is going to be a Christmas season, if there's going to a back-to-school kind of movement effort, they're going to have to increase shipments.

Okay. And second question, given that we're kind of on the doorstep here of the legacy pricing story practically actually playing out, I was wondering strategically from a negotiating perspective, have you been conditioning these customers to expect these dramatic price increases. Do they know they're coming? Just if you could provide some just perspective around how you're dealing with these customers and what their reaction has been given the fact that they face substantial price increases in the coming quarters and years?

Matt, we have worked very hard with our customers to help them understand what's happening in the market, what's happened with our legacy pricing. There's no surprises in terms of these deals. Now what we try to reinforce though also, is the value proposition, which is one, great service; and two, substantial investment going forward. Many of our customers are -- listen, I haven't met a customer that's ever going to say thanks for the price increase. But I will tell you this. At the [ph] level, when you talk with them, we get through that and they want to immediately get into where you're putting capacity for my growth in the future because they see the value propositions. So there are no surprises there. There are tough negotiations. But we have to change some of these legacy deals or we won't hold the business, I mean, the spreads are so far off of anything that's reasonable on return, on invested capital, we would walk. And in some cases, we have.

And just to follow-on, it may be difficult or you may not want to answer. But if you analyze that $2 billion in revenues that is so far disconnected from market, is there a percentage that is vulnerable to diversion, i.e. that might be able to move to Burlington or over-the-road carriage?

There is a significant piece of it, that -- that has competitive options in terms of where it will go.

Our next question is from the line of Garrett Chase with Barclays Capital.

I know that you've gotten a lot of questions on the Intermodal shipment. Just wondering, if we take a step back maybe, could you explain a little bit about what you're trying to affect? I mean, it sounds like maybe you're trying to just get better utilization out of the assets and if that's the case, how might we expect to see that play out in terms of the financials? I mean, could we see maybe a bit less pricing gain than we might normally expect but because you're getting better utilization that is going to drive the same profitability? Or how should we think about how that will play out?

Jack?

I think, Garett, when you stop and think about it, it really involves a lot of different components. One of which is, we absolutely need to get to build the business up to reinvestable levels. Number two, we want to continue to invest in the service products. I think the earlier question about, as we renegotiate these legacy deals, what's at risk. The whole thing is at risk if we don't provide outstanding service. And we have done a great job of ramping up service into the 5-year period, particularly in our Intermodal world. So that today, when customers look at the opportunities, when they look at our performance, when they look at the number of places we can take them on our network, and they see our commitment, both to the box program but also in facilities and all those, they know that we're serious about this, and that we will stand by those commitments. And some of them will test them, but I think overall, that's one of the things that is good for us. So I think getting it up to reinvestability is a key part of the pricing side of it. Great equipment utilization is all about our return on the investment that we're making on those boxes and the facilities and that's got to be part and parcel of it as well. So it's going to be multifaceted and it includes all of it.

And just a tiny one for Lance. When do you think we'll start to see the number of employees in training start to decline, just the raw number?

The raw number of employees in training kind of is a little bit sine wave through a year, right? Right now, we have almost 1,000 in the training pipeline that probably attenuates a bit as you go through the second half. The thing that Rob had pointed out though, is in terms of comparison to prior year, the pipeline probably looks similar as we move forward because of attrition and volume expectations. Does that answer your question?

Okay, here let me add one more thing though. Keep in mind, last year at this time, we didn't have many people in training. So it will be around fourth quarter -- third to fourth quarter that you're going to start to see the year-over-year comps are much more balanced because our training program really started to pick up. It actually started, I mean, we weren't doing much training towards the latter part of the year.

So it sounds like we are more or less leveling off now. I mean, is that fair with just the normal variation?

Yes, absolutely.

Our next question is coming from the line of Peter Nesvold with Jefferies & Company. H. Nesvold - Jefferies & Company, Inc.: Just a question for Rob. When I look at the operating expenses x fuel, operating expenses x fuel up 11.6% in the quarter. Year-over-year carloads up 3.1%. And even if I strip out the $14 million of flooding-related cost, you still get the cost up 11%. That was kind of like the first time we've seen a big divergence between the 2. And, I guess, number one, based on the comments that the incremental margins bottom here at 36%, how soon do you anticipate that the expense line item and the carload line item converge again? Number one. And number two, you talked about holding back on hiring if the volumes don't recover. Are there other levers that you can pull? And if you're able to quantify it, that's great.

There's a lot there. In my comments, you may recall that when you make the flood and the fuel adjustment, our revenues were up 10.5%-ish and expenses were up 9.5%-ish, a slightly better performance on the expense side than on revenue side, still not where we would like to see it in the long term. Similar drivers in, when you strip away the flood and the fuel, below that, you have personal injury was a big delta, as we pointed out year-over-year. As we talk, we've been getting ahead in the entire first half, ahead of anticipated volumes in the back half on our hiring and training, we just talked about that in the pipeline of bringing on, ramping up cost, if you will. And just the size of that, that was roughly $30 million in the second quarter alone, and you may recall in the first quarter, it was about $35 million of non-productive assets as we ramp up for those volumes. So those are some of the big drivers that account for that increase in expense that we would not anticipate seeing going forward. So your second question is when do we see the margins start to improve and when do we start to leverage that? We'd expect to see that in the third quarter. Again, assuming the economy cooperates, we're well positioned, as we've discussed here today, to lever that volume, continue to be confident in our ability to get price going forward. So we would expect the improvement from here on the margins, and you'll -- we expect to see that. H. Nesvold - Jefferies & Company, Inc.: Just to make sure I understand that because the year-over-year decline in carloads has accelerated in the first couple of weeks here of third quarter. A lot of it is flooding. I would anticipate and we will probably cycle through it. Maybe some of it is macro, I'm not quite sure. But you're comfortable that the margins improved sequentially 2Q to 3Q even despite the fact that carloads are actually getting worse at an accelerating rate to begin the quarter.

Yes, but as we discussed here this morning, we do expect carloadings to pick up for all the reasons we've been discussing here.

Hey, Peter, now if they don't, as we said earlier here, with 4,000 attrition this year, we can scale back the cost numbers pretty quickly. We show that back in '08, '09 when we had a short falloff. I'm not betting on that, when you look at it. But I will tell you, we're going to keep a very close look at what has happened with our business volume. And we do have the flexibility to cut back pretty quick. And it's not only on the labor side. It could be your locomotive overhaul program that you look at. I don't think that is going to happen. But we're prepared if this thing goes the wrong way for us to do some things pretty substantial in the cost side.

Our next question this morning is coming from Anthony Gallo with Wells Fargo.

It sounds like the risk to peak season is actually that it materializes, I mean, you're being cautious, the truckers are being cautious. It doesn't sound like they can grow even if they wanted to. The retailers are holding back. So, I guess, I want to make sure I understand exactly. If we do have a compressed peak, what kind of capacity do you have? And when do we need or when would those support loading -- when would those numbers start to come in to tell us that you're going to be able to handle the peak if it does come in?

Anthony, the bottleneck will not be the Union Pacific railroad. Again, just think about what we've talked about here. We've got a substantial amount of costs that are built into the second quarter, in terms of resources training. We're getting 100 new locomotives in place. We've got additional containers still to be delivered. We are -- I hope you're right that this peak is greater than what we expect. We are a long way from having a capacity issue on this railroad right now.

Our last question is coming from the line of David [ph] of Bernstein [ph].

It's actually Bernstein Research [ph]. A quick question on the restructuring and the Domestic Intermodal contract. Is that having an impact on the rate? Are you guys sort of moving some of the -- what you've may be price up in the peak season and trying to smooth that across the years, as well as kind of with the capacity commitments and things like that?

Yes, I think when you look at the program, David, we're making a price commitment during the off peak, as well as the peak. So obviously, we aren't sending customers to give us off-peak volume but the rates are still going up.

Okay. But I mean, is it sort of pulling forward some of that later-year rate? Or is that just a general rate increase?

It does pull some of it forward into the off-peak period.

Okay. And then the second question on the International Intermodal side, there's a little bit of a supply, demand inbalance. It seems to be forming in the container-shipping market. And I guess, I wanted to get your guys' perspective on the impact of that on legacy repricing. So if their rates are going to be constrained, how do you think that's going to impact your ability to price into some of the legacy business?

Well, David, what we have done is we've set where we believe the rates need to be to recover return on invested capital. And we look at it in somewhat of a replacement context. And if we can't get those kind of rates, again, I've said that earlier, we will walk from the business. We've put a lot of investment in long term. And again, you're right. When you look at what's happened capacity-wise in the water right now, it's not very good. But I can't let that drive our decision when we think long term and what's required for our business right now. Now what you might see is more volatility. Maybe the more it goes the little bit all water. But long term, I still think the value proposition is here. And I've got to get these returns here. It's pretty darn tough to justify the amount of capital we're putting in this business.

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

Well, thanks for joining us this morning. I am confident when we talk in third quarter, you're going to see improved performance from what we've had at this quarter. Again, if something the economy cooperates a little bit. So again, we look forward to talking with you.

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