CSX Corp (CSX) 2002 Q3 法說會逐字稿

Welcome to today's conference call. Today's conference is being recorded. Today's presentation material is posted on CSX.com. I'll introduce your host, Mr. John Snow.

Thank you very much. And thank all of you who are on this call with us to review the third quarter numbers. I think you have seen the third quarter numbers by now, they were released this morning earlier. With me are Paul Goodwin, the CFO, Michael Ward, the President of CSX and the CEO of CXT and Michael Giftos, the Executive Vice President of marketing and sales. There is no real news in our third quarter. You have seen these numbers before with our earlier release. But nevertheless, a word or two on they is important. Currently it's a disappointment to us. We missed our forecast on coal and our cost control were not where we wanted them to be. The problems of the quarter I think are a one quarter problem. Michael Ward, Michael Giftos and the whole team are hard at work to make sure we get back on track with that series of quarter over quarter and year over year improvements that have been our pattern for the last couple years. It was a difficult quarter. We recognize the disappointment that many of you feel in our numbers. And in not being advised earlier about those numbers. But as I say, I think the quarter was anomalous, and we have put the quarter behind us.

We addressed the problem that came up and you'll see a renewed vigor on cost takeouts. The whole team is putting in place a series of cost reduction programs that will put us in good stead for the fourth quarter but also for the year's ahead. At the same time we recognize the economy has not recovered as we had hoped it would. That's affected our ability to grow the revenue base. And we do have some concern about our revenue picture. More on that later from Michael Giftos and Mike Ward. The E.P.S. performed much better than rail-operating income as you know was up nicely, 60 cents versus 47, helped a lot by other income, solid marine business performance. And our ability to reduce interest costs, all of which helped offset some of the weakness at the railroad. To talk more about the railroad results let me call on Michael Ward. He's going to be followed by Mike Giftos with a review of the lines of business in terms of revenues and sales then we'll hear from Paul to wrap up the numbers. Michael?

Thank you John. Before I get started I would like to point everybody's attention to our normal disclaimer on forward-looking statements. Any statement we make about the future is based on the best information we have as of today. If the economy or other factors change we won't be responsible to update that. I would like to talk about we're aware of what this disappointing third quarter has cost us. We worked hard over the prior seven quarts quarters to establish credibility and we know the third quarter has hurt our credibility. I'll ensure you the entire leadership team and the people are CFX are committed to regaining your confidence. We know the right thing to do that is to go over a good fourth square, a good first quarter and re-establish the pattern of improvement that we have demonstrated over the prior two years and to let you know that we're committed to do that. Before I take you through the third quarter numbers in our near term outlook though I did want to emphasize that nothing has fundamentally or structurally changed at CSX. We had an unfortunate confluence of events most of which were one time in nature and are unlikely to be repeated. We're staying the course we have been on for several years and we're confident that we're on the right course. Our performance goals remain the same and we remain committed to our key financial targets for 2004 with 80% operating ratio with 50% all-in-debt level, and significant free cash flow and earning cost to capital so we remain committed to those goals. Improved service and safety are still our mantra and we believe that they are the key building blocks for our better cheaper modal conversions and our value pricing. So we intend to grow the business and offset inflationary and volume impact through productivity measures and efficiency initiatives.

If I can turn to the third quarter revenue was essentially flat versus last year. Unfortunately the coal revenue was down 34 million dollars. Prior to the third quarter we polled a number of our key producers and key receivers, we put in our own assessment and we felt that coal revenues would be flat versus 2001 as we entered the quarter. Unfortunately we were probably all a little bit optimistic and the year over year decline of 34 million dollars in a very profitable commodity such as coal hurt our profitability this quarter. Fortunately, we did have some year over year growth in other markets, which helped offset the coal weakness, and Mike Giftos will detail that revenue side for you shortly. Turning to the cost side, our on going cost reduction efforts were not sufficient to over come these several one-time challenges. And just to spend a moment on those, in late July there was a second AMTRAK derailment near Kensington, Maryland in which some kinks were pointed to as a possible cause of the derailment. As a background, some kink derailments don't occur very often. All of our derailments are only .8% of the causes of derailments. Although we're quite proud of our excellent safety record with AMTRAK we run about 17% of their route miles yet earning about 4% of their incidents occur on CSX. Despite these facts we felt we had to err on the side of aggressively protecting public safety so we took strong measures to assure safe passenger operations. We inspected our entire route structure. We welcomed the F.R.A. to do their own independent assessment of our routes, which they found to be in fine shape. We erred on the side of conservatism. If it was a close call we decided to put the heed order into effect. At times we had up to 50% of our system under heed orders and for the months of August and September we averaged 25% of our system under heed order. Finally we put some new speed restrictions on all passenger operations when a heed order was in place. Unfortunately this action s while they helped protect the public did slow down our network. Our year over year velocity improvement was only 2% versus 7% improvement in the first half. You heard us say many times that better is cheaper. Well the reverse is true, too, worse is more expensive. And we found we had increased inspection costs, train crew over time due to the slower velocity. While we're not able to precisely quantify all the specific cost categories which were impacted, we'd estimate the impact was in the range of about 15 million dollars of foregone efficiencies which we would have otherwise enjoyed absent this slowing of the network.

In retrospect would we have responded the same way? Absolutely. Safety as a way of life is one of our core values and we had to err on the side of caution to protect rail passengers. I would like to note the national safety, national transportation safety board and the F.R.A. both applauded our aggressive response and the commuter agencies and AMTRAK agreed to our conservative approach even though it did hurt the on time performance of their trains. In addition to this overall slower system we did have some other one-time costs I think we have spoken to you about before, the 10 million dollars in acquired reclaims from prior periods, the 10 million dollars of insurance recoveries that we enjoyed last year but weren't repeatable this year.

So unfortunately, these relatively one-time events did hurt our financial performance in the third quarter. I would like to turn now and look a little bit at the details, of our major cost categories. Our revenue was up five million dollars. Mike will give you the detail on the revenue side. On Labor and fringe we were up about 6 million dollars. Our labor inflation for both wages and fringes were up $25 million for the quarter. This was largely offset by 931 less employees on a year over year basis and we do remain on target to fulfill the promise we made in the 4th quarter of last year that on a year over year basis we would reduce our head count by 800 to 900 people. M.S. & L. improved by $12 million. This was largely driven by our 21% improvement in personal injury rate and 22% improvement in F.R. A. accidents. Building and equipment rents increased 11 million dollars versus 2001. That was driven by the prior year's reclaim by other railroads. Inland transportation was up by 18 million dollars and I would like to talk a little bit about that.

This cost category of inland transportation is due to the uniqueness of our separate intermodal company. CSXI is the only railroad-based company that has the ability to deliver a transcontinental intermodal product. So rather than offer the rate and the service to an interchange point such as Chicago or New Orleans, CSX intermodem can offer a product from L.A. to New York or L.A. to Jacksonville. It is a unique product and it's showing a good market acceptance and good growth. And it's good business for us but it does have some unfortunate optics on our expense reporting. A significant portion of the revenues for these transcontinental moves is for the western portion of the movement, which goes to the western railroad. This is reported as an expense rather than deduction from revenue. So while increased costs is usually a negative, in this case it's a positive since there is fueled by growth in this very attractive market segment. So while it's up 1 8 million year to year I viewed that as a favorable even though normally one wouldn't view an expense as a favorable. On the fuel side we were $14 million favorable with $13 million of that related to fuel price.

But as you recall we did have a surcharge in place last year in the third quarter. That surcharge has also disappeared, so while we saved $13 million in price we lost $9 million dollars in surcharge so the net impact of the price decreasing was $4 million dollars. Overall our operating income was $227 million down $10 million from last year and clearly not acceptable to us and certainly not acceptable to our owners. Now with that let's turn to our safety and service side. Looking at a few key measures, safety was 21% improved on personal injury and 22 % on F.R.A. accidents. Unfortunately a lot of our service measures were impacted by that system slow down that we experienced in the third quarter. You'll note while moment of our key measures are improved year over year, they did not improve at the rate we expected or a rate similar to that which we experienced in the first half. Our velocity was up to 22.2 miles per hour at 2- 3% improvement but that compared to a 7% rate of improvement we experienced in the first half. Our dwell was down to 22.6, a nice improvement of 7.4%, but not quite reaching the 11% improvement that we made in the first half. Our on time originations were up to 91.9% of 2. 6% improvement against the 8 % rate we were experiencing in the first half. Rate grooves got worse, 3.9% worse where we experienced a 23% improvement in the first half and cars online improved by 5.7%. We do expect to get much better year over year improvements in the 4th quarter and as we return to the fourth quarter we expect operations will be back to normal. The heat quarter season is over its basically when the temperatures are over 90 degrees, that's clearly behind us now. We did three jamborees this year and we spent extra capital to harden our track infrastructure, and with that we will be paying dividends as we go into the fourth quarter. And we'll resume the better year over year improvements which fuel is better for our cheaper model. We're embarking on even more aggressive cost takeouts. We are employing one golden rule, and that is we cannot hurt service or safety, which are our foundational building blocks. What kind of actions are we undertaking? One we're sizing the train impact to the business levels and during that without impacting the service to allow to us save some of our train starts. We're working with our customers to pre-ship if necessary to allow to us do some more extensive shutdowns of operations during the Thanksgiving and the Christmas holidays. We're intensifying our safety efforts. We continue to drive to improve that. We're going to attack all the usual suspects. Looking closely at our travel cost, our relocation costs, we initiated a hiring freeze for the remainder of the year and will probably engage in selective furloughs. We will achieve or exceed the 800 to 900 year over year head count goal. We'll be putting strong controls on all discretionary spending in the fourth quarter. There's one thing we will not be doing and that's we will not engaging in extensive deferrals to make our 4th quarter margins look good. Again looking in the fourth quarter in coal, we think some of the challenges we faced in the third quarter will continue to the quarter and obviously there is some sensitivity to that on the west coast longshoreman strike. Mike will give you some points and discussion of that next. On the fuel price there is uncertainty in the oil markets that the threat of potential war with Iraq. But we do have 50% of our fuel advance purchased at roughly 78 cents per gallon for the quarter. Overall we expect a much stronger fourth quarter than we produced in the third quarter. Finally just to turn to a longer-term outlook. A fundamental has thought changed. We're committed to our 2004 goals. 80% operating ratio, 50% all in debt ratio, significant free cash flow and earning our cost of capital. To achieve the 80% operating ratio goal the cost takeout will play a larger role. As you know from our summer alleys tour which many of you joined us our goal was to grow our revenues by $one million and you may recall 40% of that was to come from modal conversions, 30% from value pricing and 30% of it from the economy rebounding. We still feel very good about our modal conversion and value pricing initiatives but the economy is very questionable at this point in time. So we're aggressively increasing our focus on costs to be able to meet 2004 financial goals, which we are committed to. Now I would like to turn the program over to Mike Giftos to discuss our disappointing revenue performance in the third quarter. Michael

Thank you Mike. Good morning. I think Michael that the use of the word disappointing is the accurate word to describe our third quarter revenue performance. It was a quarter where our overall revenues grew by a modest $5 million where growth in the merchandise in our intermodal areas, modest growth was largely offset by 34 million dollar year over year decline in our coal revenues. Clearly, this contributed significantly to our failure to meet our expectations, your expectations and we're keenly aware of that disappointment. Let's look at a little more detail at the coal issues at CSX. The coal numbers are down $34 millions. That's a 7.8% year over year decline in revenue. This occurred in 6.1% decline in carloads on 1.8% contraction in revenue per car. I'm going to explain this by showing you a slide that's a little bit busy but I think does do a good job of explaining our coal story. This slide depicts all of our coal markets as you can see from the first two buckets of revenue, that's our utility coal, which we divide into utility north and utility south coal. The volumes in those two areas were essentially flat year over year, up a modest 1% for our utility business. But we see significant declines in export and light coal down 40% each. Industrial coal and our coke business were all down approximately 15 to 20 %. On the other hand our river coal, that's the new type of business we talked about in the past, that's short haul business that is up a significant 30% as we continue to take trucks off the highway and move those short haul shuttle trains to the river served markets. The net effect of all this is a significant decline in our coal volume year over year and contributes to the overall erosion in our year over year revenues. One of the factors contributing to that? Well they are multiple. We've had plant closings; some key customer closings with the most notable to CSX is the L.T.V. business, which was a significant contributor to our year over year revenue decline. We also see the general international competitive situation affecting some of our export business. Last year at this time we had a key Italian based electric utility that received coal from us. That coal is now being sourced from South Africa. Significantly contributing was the overall business environment with a number of our industrial customers where they simply took less volume this year than they took last year.

Finally we did have some business that we lost in the lake market due to tough competitive pricing issues. The slide also does something else I want to spend a few minutes on. We talked to you consistently over the last few quarters about our focus on yield improvement and this quarter we don't see the type of yield improvement we're accustomed to seeing. Our revenue per car deteriorated overall versus last year down $18 down to $962 average revenue per car for all of these businesses. If you see the slide in front of you you'll notice a series of dots. I put those on there for a specific purpose of trying to explain how mix is significantly impacted revenue per car. So if you focus on the river coal market just for a moment you'll notice a red dot there. The red dot indicates and signifies that the revenue in that business is down over 400 dollars per car below our average revenue per car. That business is up 30% year over year. The arrow in the far right hand column signifies its impact on the low revenue per car business had a significant downward effect on over all revenue per car. If we look at another market on the other hand, the industrial business is down 15% but in that market we have revenue per car that averaged over $400 more than the average revenue per car so the volume is down 15% in a line of business that averages over $400 more of revenue per car than the average coal business. That had a significant negative impact on total revenue per car. In a remarkable confluence of events you can see from the arrows in the far right-hand column the combination of revenue per car and volume changes in every one of those markets tended to negatively impact total revenue per car. The total impact of mixed changes on revenue per car was a negative $35. This was substantially and significantly offset by our continued efforts in repricing our coal business, which contributed an additional $21 per car but not offsetting all the effects of the mixed changes.

We continue to focus on price and we continue to receive the business for the full year high single digit rate increases in our coal business. This clearly coal will remain a challenge for CSX in the short term because a number of the structural changes that I referred to that the business changes that we saw in the third quarter will impact us in the fourth quarter as well. If we look at the remainder of our businesses excluding coal we see that our other revenues grew $39 million year over year from 2.9%. Our merchandise revenue was up $19 million or 2.2 %, Automotive revenue up $11 million or 6%, and intermodal was up some $27 million almost 9.5%. But our supplemental revenue the bucket of revenue that includes switching charges, passenger incentives, and the lakes own a year over year basis was down 18 million dollars. Let's spend some time looking at the individual commodity groups, first of all beginning with our automotive area, which was up $11 million, which is a modest per car improvement. But we're all aware of the auto story, where Light vehicle production remains strong, much stronger than a year ago. Throughout most of the year producing in the 16.7 million units of domestic production versus 15.5 million last year. Inventories at the end of September were at approximately 57 days, which is close to normal. And we continue to expect this to perform well largely because of the significant incentive that remains in place at a number of our auto producers. The yield improvement is not attributable to price as I have said in the past. This is largely a function of favorable mix and longer haul service.

Turning to our intermodal sector, the intermodal sector performed quite well this quarter. Our total revenue was up $27 million, 9.5% on unit growth of approximately the same 9.5% as well. Our international business was quite strong largely because of the economy, and the imported business was strong. And some pre-shipping in anticipation of the west coast labor unrest. Domestic business was strong up 12% and that included offsetting the decline, the year over year decline in our premium sector. We continue to enjoy significant modal conversion in all of our intermodal sectors and expect that's a trend that will continue for us as we move forward. In our merchandise business it's again a story of a number of mixed markets. The total revenue was up a very modest $19 million, 2.2% on carload volume increases of 1.6%. Strength in our metals, chemicals are an emerging markets and strong phosphate business was somewhat offset by weakness in the agriculture, and minerals and food and consumers areas. We expect to see these trends continuing but it has a lot to do with the condition of the economy. On the yield side we saw a very modest overall improvement of cold front 6% in our revenue per car. But that story as was the case the last time we met is somewhat distorted by our magnificent performance in the phosphate business, and this is virtually similar to a slide that you saw last quarter that shows the phosphates are performing very well where the business is operating actually at 97% of capacity, where we enjoy terrific exports of phosphates largely to China. That business is very, very good where it produces average revenue of $260 per car versus the 1245

Suspension of audio --

We had some audio equipment problems and apologize for dropping off for a few moments. Another third quarter challenge for CSX. I think where I was my note I was talking about the year over year change in merchandise yield. Pointing out much like the last quarter we find the yield story somewhat masked or distorted by our phosphate story. It's a business that I have indicated that business is very strong. But it's a business that moves at average revenue per carve $260 compared to the overall revenue for car and merchandise of over $1200. That phosphate business was up 10.5% versus a year ago but tended to understate the overall yield improvement. If you look at slide 17, excluding the phosphate business you can see it was up some 1.6%.

As we now turn to the customary slide where we look forward at our business for the immediate future, you can see how I see the businesses for CSX, how we see the businesses, the color codes indicate how things have changed from the last time we met. Our coal business as I indicated earlier we expect for the foreseeable future to the near term that it will be unfavorable as we continue to see weakness in the export business, the coke business, the lake business, for which I mentioned earlier, we will not be able to offset that with our utility business which we expect to be substantially flat. The minerals business is very small piece of CSX's revenue, about $135 million on an annual basis. For the same types of trend we talked about before, largely foreign source competition, we don't expect that to be favorable year over year. We have a number of markets that we expect to be essentially flat, although we're seeing some encouraging signs that some of those may be impact positive. The food and consumer business we continue to see strength in our express lane product. But the growth that we see there is somewhat offset by weakness in the originated refrigerator products that exist on CSX today. Paper and forest product line segments continue to perform much as they have in the past with the strong performance in the building products somewhat offset by the weakness in the newsprint areas. Our emerging markets business units have done well growing over 4%. Its facing some challenges with quarter year over year comparisons and we expect that to essentially be flat. The phosphate and fertilizing business is operating at approximately 97% of capacities. Year over year comparisons are challenging because they are performing quite well in the fourth quarter last year and we expect that to be flat. We expect favorable markets, the intermodal business; the great unknown there is the impact of the labor unrest on the west coast. We continue to see strength in the domestic business, the Intermodal conversions. The great unknown is the impact of the west coast labor unrest. The levels and volumes occurring prior to the unrest beginning, the strike beginning have not returned to CSX. We expect those to come back a little more quickly than they have. And we remain concerned about exactly how that situation will play out as we move through the quarter. Our chemical business has grown nicely. We expect continued modest growth in plastics and techs tile chemicals and we expect that market to perform favorably. The automotive business will continue to perform nicely compared with last year. And that is a trend that we expect to continue. The metals business is performing nicely for CSX today. Sheet steel business continues to be strong and the steel producers are operating at high levels of capacity. In our agriculture business we expect to turn favorable in the quarter versus last year as we begin to enjoy some longer haul revenues, the length of haul will be longer because of substantially weakened southeastern crops due to the poor crop season.

In conclusion, our story is pretty much as Michael said and summarized on my final slide. Continue to be challenged by the coal market. That will continue to challenge CSX in the fourth quarter. The west coast strike and west coast labor unrest, there's a lot of uncertainty surrounding that. We expect most of the volume that was delayed that we haven't recognized will be captured as we work through the remainder of this quarter. But a lot depends on if the workers will return to work and perform in ways that productivity level that existed prior to the commencement of the labor unrest. Field surcharge, that's a sensitivity, it's a positive sensitivity. CSX as you may recall has a fuel surcharge program. It went into effect on October 17 as the price of west Texas intermediate crude stayed above the target price of $28 a barrel for more than 30 days. That began on the 17 of October and should contribute $6 million of incremental revenue to CSX transportation and $2.5 million of incremental revenue to CSX intermodal in the 4th quarter. Finally the perhaps the most significant sensitivity is how the economy is going to perform. We don't have a crystal ball that's any better than the crystal ball any of you have and it remains a concern to all of us that we are confident CSX that we have in place a combination of cost initiatives coupled with the revenue growth we see in the markets I previously indicated so our fourth quarter performance should be a nice pickup over what we have seen in the past. With that I would ask, or I will turn the program over to Paul Goodwin.

Thank you, Mike. Good morning. I think you pretty much heard the story at surface transportation. But I'll share a few other numbers and highlight a few more points about CSX's overall third quarter. The chart, which shows the quarterly results, is one that we have been sharing with you each quarter. As John and Michael have said, our third quarter this year was disappointing. The $227 million of operating income being below that of third quarter last year while we're disappointed, we expect that next quarter when we share this sequence of operating performances with you, we'll have resumed the up trend which would characterize the numbers up until this point. The marine services chart lays out what our smaller companies did during the quarter. As you know world terminals has a majority of its earnings coming from is Hong Kong operation, but it has 11 other terminals that it operates throughout the world. The collective earnings improvement from those operations was about a million dollars. But in the quarter we have $3 million of separation payments in Hong Kong and Australia, which should improve productivity and continuing operation s going forward. Net $2 million decline in the quarter as a result of that activity.

CSX lines as you know operates the three trade lanes to Alaska, Hawaiian and Puerto Rico. We're very pleased with the strength in from Puerto Rican trade, which account for a main share of the year-to-year improvement of $5 million. Our market share went from 25% to 35% and as a result of the restructuring of Navieris' operations, Alaska's earnings were off slightly but more than offset by a pick up in Hawaii. So we're pleased with the progress at our marine services subsidiaries.

Now turning to the consolidated results, you've heard the story about our operating companies, operating income was down $6 million but overall a met earnings improved in the quarter some $27 million to $127 million or 60 cents a share up 13 cents. You can see from the chart, the big pickups came in other income, what we had there was a major real estate sale, which was responsible for the year over year improvement. The gain in interest expense of some $21 million is roughly half the result of financing at low interest rates last year in anticipation of this year's maturities. The other roughly half of that improvement comes from increasing our floating rate debt through a swap program. The next chart lays out the consolidated results for nine months. 2002. And for the nine months you can see the operating income pick up was some $73 million other income improvement of $29 million represents the flow through of the third quarter favorable. And our interest expense benefit of $59 million extends those savings that I described through three quarters of the year. Net earnings as a result were up $10.2 million and at the nine-month point we earned $ 1.55 a share or 48 cents. As a result of this nine-month activity the financial position of CSX continues to improve as highlighted on this next charts. Free cash flow at the end of nine months is $58 million. That contrasts with the negative number through nine months of last year. I shared with you that we expected to generate free cash flow of some $100 to $200 million. As we see it right now, we expect to come in at the lower end of that range, but still within it. Our debt ratio improved from the end of last year and now stands at 57% as measured by all in debt, including off balance sheet leases and receivables financing. Our EBID dot coverage is 3.9 which moved up from the 3.1 times that we logged at this time last year. So we're building debt capacity or cushion above our triple B credit level, triple B minus break point, if you will. That totals some $300 to $500 million.

My last chart the bar graph which shows leverage over a longer period of time expand the perspective on that debt ratio number. As you can see 1990 through 1994 our leverage was significant peaking at 67%. Those high debt levels reflect borrowings to finance share buybacks in the late 80's. Our credit rating improved when the debt ratio dot down to the 5 4% level and increased to 63% following the Conrail across question acquisition. It is now coming down. We expect that trend to continue and while we're in the process of developing next year's plans, as we look ahead to our cash expectations and debt retirements, we think we'll be back down in that pre-Conrail 54% range. With that, I'll turn the phone back over to John.

I'll be brief. We're going to go to your questions now. First just a word. Clearly it was a disappointing quarter but we have emerged from it I think stronger in a lot of ways. With a renewed dedication to our long-term goal s, and as Michael Ward said, with a heightened focus on improving our cost structure. I'm confident we put the problems of the quarter at the rail group behind us and look Ford to reporting much stronger results for the fourth quarter and beyond. And with that we will go to your questions.

We're ready to begin the question and answer session of the call. Our first question comes from Tom Wadwith.

I wanted to see if you could provide further specifics on the focus us on the cost side. You are maintaining the 2004 targets you have but said more is going to come from the cost side. Is that really any numbers should we expect more in terms of head count reduction or are there other areas can you give us any numbers to work with in terms of head count reduction maybe next year or just some order magnitude numbers.

As Paul indicated we're in the process of developing our 2003 plan now. So I can give you some indicia but not necessarily all the details you might like. Clearly we're looking to deploy technology strongly to help us continue to push the APU's which we think are a great fuel saving device. We will continue to push the remote control locomotives. We're testing some devices at this point to allow us to reduce some of the clerical workforce required on some our event reporting and some mechanization of some of our crew calling processes all of which will probably have some favorable headcount type of improvements. We're also looking not so much at the operations in the field but within the headquarters is our ability to do some surgical improvements by consolidating some operations and increasing the efficiencies in some of the headquarters operations to allow us to allow to us take better advantage of the attrition. We'll probably be better able to give you a head count target once we have gotten through that planning process. But it will at least be at the level we have seen this year probably stronger. In addition we're examining some of our network. We have some, what we call big initiatives and ease doing business, event reporting and shipment management that will let us continue to take the service up to the next level, better provide a good excellent product for our customers to help support our price but it also helps withdrawing costs out of the system as we do that. We probably also will be examining some of our terminals to see whether some of our hubs can be deployed as a flat yard. Looking at some of our secondary lines to see if there is a better use those lines. So we'll be investigating a number of potential activities. We'll probably also look at retiree medical, which is a creeping expense for all American companies. We'll be examining a broad portfolio of items that we intend to start deploying next year.

Great. I have one other question as well. Maybe for Mike Giftos, maybe for Michael as well. On the field side, I think one of the concerns given fuel prices are quite volatile and have been high recently as we look at 2003 my understanding is you don't have much of a '03 consumption hedge. Can you update us on this number and give us a sense for how much of the risk to fuel prices do you actually recover with these fuel surcharges. What percentage of total revenue or business is actually impacted by fuel surcharges.

Two things. One, we didn't do any hedging this year just to be technically correct. What we did is advance purchases of the fuel . We have not done any of that for the year 2003. In the August-September time frame we did set some target prices we would have been willing to buy on an advance basis. Unfortunately the forward [unintelligible] never got to those levels. So going into 2003 we have done no advance purchases of fuel. On the surcharge recovery I'll give you a roughest estimate, I think probably it's in the order of magnitude of a 60 to 65% recovery of the impact of the fuel price on us through the fuel surcharge. So we're not fully recovering the impact that as we go forward.

Does that translate to 60-65% of business where you can actually apply a fuel surcharge? Is that the right way to look at that?

No, I think this is Mike Giftos-- what Michael is saying is we have to do some estimating of what we think the total fuel increase will be attributable to increased prices and we look at how we see it applying it to the business sectors where it applies and we estimate we'll recover about 65 % of the increased fuel price that we're estimating.

Ok.

Not necessarily 65% of the customers. It's what the recovery will be, right?

Right.

Great, thanks for the time.

The next question comes from James Valentine.

Two questions. First, maybe for you, Mike Giftos. In terms of the quarter Norfolk Southern's non-coal revenue grew 7% and yours grew much slower than that. In railroading you don't tend to see big market share shifts from one quarter the next but I'm trying to understand if there's any component here your competitor is taking share or is there markets their specific areas are just growing at a faster rate than what you are seeing?

Well thanks that's a terrific question, Jim, and it's frankly a question that I expect and the question I have asked all my market managers as well and a question we're currently addressing. We do know in the coal area we can largely account for those changes. I explained them to you earlier. I think that frankly the starting point in the coal area is last year Norfolk Southern had a very weak third quarter. And that explains parts of it. We can also explain part of it because our business mix, the closure of L. T.V. had a significant impact on CSX and Norfolk Southern had nothing comparable to that. There is the lake business where we did lose some business to Norfolk Southern because of pricing activities. Were examining our commodity areas and we'll have a better understanding of that as we go forward.

I'm sorry, how about the non-coal business? That's really what I was trying to focus on.

Excuse Me. That question is one that will be more fully assessed in the next week, Jim. We know of certain areas where we lost business because of our pricing activities. We have been a price leader and we understand that. And we watch that very carefully. I don't think it's a dramatic amount, but a couple million dollars of loss of revenue to us moving the other way here and there begins to add up.

Right, exactly. And that leads to my second question for Mike Ward. That when we look at 80% operating ratio in two years from now and let's assume that's for the current year and I'm also assuming that that's for CSX and [T and I] combined, at current revenue levels you have got to generate an extra 50% operating income and presuming your revenue grows which I agree it will, likely will, the number gets even bigger And I'm trying to understand let's just say it's 500 million of operating income, how much of that will come from revenue versus cost cutting when we consider that I think a lot of the big pricing initiatives or the pricing help , as you described it has been picked here and therefore we need to look more at volume growth. How do you get to the 80% operating ratio broken down between revenue and cost?

Jim I can't give you necessarily the precise numbers on that but you are quite right we have to pull the cost lever harder than we had in our modeling we did this summer. We do think by 2004 the economy will have rebounded to some extent, but who knows. It's been over 2.5 years this economy has been in an industrial production recession. But we do need some help from the economy. We think by 2004 we'll see some of that. We think the modal conversions will build momentum as we continue to improve the product and while the pricing obviously you -- we had some earlier hits there still is good vibrancy to that. Maybe not at the same rate as early on. So we think all three of those will give us some pretty good revenue growth during that period. Probably not the one billion dollars because we work out on the economy some. I think we'll find as really we put this put this more aggressive posture on our cost side it will be a much more important element in that. I can't give you the break down at this point how much of it is revenue and how much it cost but it will be a more cost -driven model than we described to you this summer.

OK, Great. And one last thing just to make sure when get this on the table in terms of marine because of the west coast port strike. I guess you guys have the Hong Kong terminal but you also have the [unitelligble] trade. Is a positive or a negative for the fourth quarter?

This is Paul, Jim. The west coast strike is a negative for the marine services in the fourth quarter. There are a lot of variables, duration, and what the unions might do separately from the domestic trades verses the international so we can't put a, quantify it very well. But it's clearly a negative on lines.

Thanks for the updates.

Our next question comes from Scott Flower.

Good morning gentlemen. Just a couple questions and I guess one would be somewhat broad related to the quarters and also the seemingly greater focus on cost takeout. I guess when I look at the numbers I think about things sequentially versus year over year so I certainly understand that coal is down but yet coal is not down more than what it was in second quarter and certainly if I look at the seasonal drop in revenues it wasn't worse. I understand the 10 million of reclaim and the 15 million if you will foregone efficiency costs because of slowing the system down but yet operating income fell something close to 60 million in those two items would act for 25 or 30 so I'm still trying to figure out sequentially, not year over year, why the operating income numbers still fell as much as it did roughly another 30 million. One of the questions I have and it comes back to your comments about longer term looking at the cost side. It sound like the industrial economy didn't come back as strongly and you decided later that you had to pull back more in resources. How hard or how quickly can you determine that relative, that why wasn't that caught earlier relative to the economy wasn't stronger versus the amount of resources you were putting up against that business plan?

You asked a couple questions there, Scott, but let me try to see if I can answer those. One, you might like to look at it sequentially but we have a seasonally based business. Last year, if we just go back a year, our operating income year over year declined as well because normally our quarters the fourth is the strongest, the second is the second strongest, then the third and the first. So you do get some of the seasonal impacts of coal miners' vacation, automotive shut down, both of which are fairly compensatory businesses. In addition that's our heavy maintenance season so we're out there doing lots of work on our track structure, which does inhibit some of your velocity movement. Your probably spending some more OE to support some of those capital programs. So I don't think it's at least in our view a real good way to look at necessary sequential because there are there are seasonal differences between the quarters.

But if you look at last year it only dropped five million dollars. I realize I'm on the same page with you and the seasonality but yet you are also [sectorally] improving.

Well, I don't know how to answer your question. I usually don't think about these things sequentially. It is not the way we do our business. And we always look at our year over year how do we deal within the same sector.

Fair enough. Then two other really quick questions. One was depreciation jumped up notably from second quarter and typically the numbers don't really take that kind of move almost eight million and then one thing Mike Giftos mentioned, other revenues related to whether it demurred or otherwise dropped sharply. Was that sort of a one off type item in both those areas both the depreciation as well as the other revenue line items it was a little lower than it typically is?

Scott this is Paul. The depreciation, the year to year comparison is as you would expect with capital expenditures each year adding to asset base. The first half of the year had some adjustments in the property accounts so I think the year over year change is more representative of trends. Regarding the supplemental revenue or the other revenue category, that category includes a myriad of items. I think on a normal quarter next year going forward we expect that revenue to range in range in the 15 million to 18 million area. Last year it was higher, this year it was lower. The principal reason for those deviations, if you will, from the norm are several things, passenger service revenue was down , excuse me, passenger incentive revenue from Amtrack was down with the slowdowns that Mike Ward talked about. We have a lot of switching payables in there which happened to be up, to merge is a big item. That was off year to year and we had some disputes over some of those revenues which were concluded in the third quarter. So I think you are seeing unusual deviations from the norm. But next year we'll probably be back at more of a normal level.

You answered this, I just want to make sure. Depreciation where it is now, we should consider a run rate adjusted for sort of normal cap. ex. increments that slightly each quarter is that correct?

I don't have my micrometer but my sense is that's right.

Our next question comes from Jason Skeeto.

One quick clarifying point on the fuel surcharge. There was supposed to be $6 million incremental at CSXT, and was it 6.5 for intermodal?

No, 2.5 million it our estimate of the intermodal number.

That's what I thought I didn't hear you clearly. That is my fault. Going forward on fuel, you mentioned the hedge position for the forth quarter, can you refresh my memory where you are at for 03.

Again, not hedging, but purchasing. For our fourth quarter this year we purchased 50% of our estimated fuel requirements at 78 cent price. For 2003 we have done no advance purchase of fuel at all.

Switching to the west coast ports we said there was obviously going to be an effect at CSX lines. I'm assuming some of that comes from the Alaska service. What are we at right now? Are we close to normal in terms of the ship schedules?

There is a backup at both of the west coast ports Oakland which serves Alaska is got better through-put closer to normal though it slowed down somewhat. So Alaska we don't expect to be as negatively affected as the Hawaii trade.

So Hawaii.

It's out of Long Beach.

Switching -- same kind of with west coast ports -- the comment about the length of haul to agriculture. Can I assume that has to do with some people diverting shipments to other ports?

No, it's not an export issue. It's largely the southeast crop. The crop that was very strong a year ago is very weak this year. So the movement of feedstocks into the feed mills in the Carolinas that we serve is going to come from a longer haul rather than being displaced by the shorter hauls that were available last year. We'll have a longer haul agricultural revenue base versus last year's shorter hauls.

At least for the near term, right?

The near term, correct.

Gentlemen, thank you.

The next call comes from Ken Hexter.

Good morning. Ken Hexter from Merrill Lynch. I'm just wondering if you could provide a couple more details on the real estate sale and then any progress -- any update on if progress has been made on some of the marine divestitures or if that's still in the plans. And then Modal conversions you guys usually give out some kind of details on the number that you converted if we can get some trends and finally what was the cap -x number for the quarter.

The real estate, we had, real estate sales we have activity in every quarter. And this most recent quarter we had a large sale, pretty much entirely accounted for the year to year pick up in income. In the first half our numbers were comfortable year to year, although I don't think the timing hit the same quarter, in the first half. But this year was had a couple, two or three rather large sales and we're gratified that the realty people's efforts have produced the cash and the result that they have. The fourth quarter I think doesn't have any of those large transactions on horizon. The first nine months I think has captured all of the big sales. Regarding marine services, potential divestitures. As you know we always stand ready to listen to people who feel some of our assets would be more valuable in their hands and so then so we're willing to listen to anyone who expresses that interest. But there is nothing more we can really add to that general posture. In terms of the revenue item, was that about modal conversion.

Yes, our modal conversions are on track largely following the trend we previously indicated. Substantial growth in the river coal business, that I indicated on the slide, is a significant contributor. The intermodal volumes are up nicely. We expect that to continue. In the merchandise area significant modal conversions again, offsetting some of the overall weakness in our commodity groups that's largely attributable to the economy. So we're on track to meet or exceed our modal conversion goals.

Ken, I believe you had one other question on cap x.

For six months, what was cap x?

I think we can find that for you. I don't have it off the top of my head. Why don't we let Fred Elliason get back to you with that.

Just a quick follow up. On the 100 million of free cash flow can you provide us with how much was from Conrail for the year?

I don't have that handy either. What they produced -- they produced a nice sum, I call it significant as you know the rent that we pay them exceed their needs. So they generate positive balances every year. But I don't have the figure.

Thanks, Mike's, thanks , Paul .

Our next question comes from Jordan Alger

Goldman Sachs. Couple questions. One, on the non-utility coal, understanding that's going to be tough in the fourth quarter what actually eventually turns around that business? Is it more economically sensitive, is it competitive reaction on your part or is really just anniversary-ing things three quarters down the road.

I think some of the negatives will recycle. The LT business we lost last year early in the fourth quarter so the year over year effect of the closure won't be as dramatic. But some of the businesses are simply competitive and they will change with market conditions as they change the price of the international coal from south Africa was more competitive with U.S. last year and we were able to get that utility business moving to Italy. So it's a variety of factors that are economically driven. The base business, 70% of our coal revenue is related to domestic utilities. We expect the domestic utility production from coal to grow on an annual basis by about 1.5 % assuming normal weather at that business should perform quite nicely and we're continuing to enjoy rate increases. The other sectors will be affected by general market conditions.

Just a followup and this is maybe more of a semantic question. The indication that the problems behind the company in the third quarter and looking forward to deliver stronger fourth quarter results I assume we're talking total surface transportation but I'm wonder if you are thinking sequentially versus the third quarter or a year over year basis or both?

One, we're talking about service transportation and secondly the answer would be both.

Thank you.

The next question comes from Gary Appelin

Thank you, First Boston. Paul, could you talk about some of the pension topics that have been popular lately , expected rate of returns, funded status and whatnot?

Sure. The plan is -- when have a couple plans. The big plan covers the railroad and corporate and is fully funded. Some of the smaller union plans are not quite fully funded but they are in pretty good shape. Overall as a result of that what I would call full funding status this year we basically had zero, I think it was maybe, two or three million in pension expense that we recognize, principally related to those smaller marine service and union plans. Over the past 10 years we have earned 12.2% on the assets in the plan. And that compares to the current earnings assumption for accounting recognition purposes 9.5%. However, in the last five years of that decade experience I just quoted we were under the 9.5% and we're currently working with our investment managers to assess what we think is appropriate as we look forward. We think it's very possible we may be notching down that earnings assumption. It would affect pension expense next year but you know as you know, the accounting estimating process differs from the funding process. And we don't expect to be making in any quantities immediately and long term that will of course depend on market returns and whether we can get back up to those higher expected levels. So we think the plan is in good shape. We'll have some higher level of expense next year. Exactly what assumption s we don't we think they will be more conservative but we haven't finished that process.

But as relates to [truing] cash up into the fund that's not necessary? Is that what you are saying?

Yes. We have very minor contribution s that we'll be making next year to the union plans and the marine services plans. They are very small. As I said our big plan is in good shape.

A question for Mike Ward. Could you step back and tell us how you feel structurally bout the physical plant of the railroad are you ahead of where you need to be, is there still catch up as relates to dollars to spend and whatnot?

As you know, Gary, over the last two and a half years we have been hardening our infrastructure all along. You'll notice in the capital programs we have been devoting more of that to our track structure over the last couple of years and we think we're getting into to a very good set of conditions and not that it was in trouble to begin with but when really are strengthening it so we can push the velocity, push service to our customers. I would expect to see spending in the range of what we have been spending for another year or two as we continue to strengthen it but it's getting in pretty good shape now with the monies we have spent on replacing ties especially here in the south and replacing rail. I think wear getting to a strong infrastructure and will probably the next couple years continue to strengthen it some more because it does help us drive velocity which drives a lot of other things in our cost structure.

So the plan that relates to the 80% and the billion dollars or thereabouts. It assumes fair bit of an increase in revenue but it assumes pretty much an absolute dollars a flattish capital prom.

I would say relatively flat. I think we've talked all along about a billion give or take 50 and that's probably the ranges we continue to be in.

Thank you.

We have a follow up question from Scott Flower.

Wondering if we can follow up on two broader items. Where do you see the status of the health and welfare negotiations with the UTU line? I know there is a prescribed process of fact-finding or looking at ways to save money and then it eventually goes to arbitration. I'm just wondering where are we in that process and how do you see it moving forward to some kind of conclusion. What kind of timeframe?

I guess Scott, as you know, Those are always very sensitive things to discuss. They are in discussions now between the carriers conference and the U.T. U. on potential adjustments to the health and welfare programs. I think I can't say a lot more than that. They are in active discussions at this point.

Well could you tell me within the contract how is the process laid out? Is there an indefinite period of discussion or is there a finite timeframe before it then goes to some form of mediation or arbitration? I'm wondering what's in the contract not to get you to comment on what's in the negotiation.

There is a set time period in which the negotiations can occur. Off the top of my ready think it's a 90 day period for those negotiations at which point it would move into the binding arbitration.

And do you know when that 90 day period either started or ends?

I don't.

And the other question is, the S.T.B. announced some changes in the rate case process announced changes in terms of discovery in trying to expedite the process. I think some of this was in response to the hearing Senator Roe held. Do you have any feel one way or the other, what those changes may or may not do to the rate valuation process that shippers can bring before the S.T.B.?

We don't anticipate any major effect on us from those changes. It's an effort to speed up the process and make it more usable and effective for small shippers. So it's really a small shipper focus. And it is in response to a lot of complaints by small shippers that they find the processes of the S.T.B. burdensome. So I don't contemplate any major effect in the cases that are of greatest importance to us.

So this has no change in the discovery process for larger shipper cases?

This is a small shipper procedure.

Thank you very much.

The next question comes from John Barnes.

Good morning. In looking back at the river coal traffic, Mike, can you give us an idea. Is it possible at all to eventually turn some of that shorter link or haul trafic into longer link or haul and bypass the river?

There are some projects we're looking at that we expect we'll be able to get some longer lengths of haul. But they are a distinct minority. Most of that business is business that we expect will fall much in the mode that is reflected on my prior slide number 12. And it will carry a lower revenue per car. But with a rate wear able to turn the cars it's attractive business and we're aggressively going after converting it.

Second question, just a very broad question on pricing in the eastern markets. You indicated that you felt like you lost a little market share in the lake business because of pricing and I think you made a comment that some of your pricing activities in the industrial side had led to a little bit of market share shift. Just very broadly are your marketing people telling you that maybe the situation in the east has gotten more competitive than it was six months ago and has there been a seismic shift in the sentiment, the pricing and the sentiment in the eastern markets?

Well, there's been no seismic shift that's at all discernible. You and I would clearly know about it. Were clearly concerned in a few markets about losses of business. We're in a very competitive world. When understand that. We have been a price leader and we understand that the cost of leadership can sometimes be losses of business. We have seen that in a couple markets, some of our agricultural business and a few other markets, we watch it very closely. We remain committed to our price leadership. But we're obviously have to be cognizant of fluctuations because in this economy with it not providing the bottom line demand that we need those things can get exaggerated and it's important to watch them all very carefully.

open

We thank you for being with us and look forward to seeing you in New York for better results for the fourth quarter. Thank you very much.