CSX Corp (CSX) 2003 Q2 法說會逐字稿

Good morning, everybody. Before we get started just want to remind everybody that today's presentation will include forward-looking statements and that actual results might differ from any forecasted information presented here today. Factors that might influence actual results are listed on the disclaimers line in your presentation and also listed in the CSX annual report. With that I will now turn the call over to your host, Mr. Michael Ward, please go ahead, sir.

Well, good morning and welcome to CSX's second quarter earnings release presentation. I appreciate you joining us today. With me today I have Michael Giftos our Chief Commercial Officer, Oscar Munoz, Chief Financial Officer and Al Crown our Chief Operating Officer.

You've seen the numbers and, in my view, we had sort of a tough quarter here in the second quarter. As you know, our business model is to pull both levers, grow the revenue and reduce the cost through productivity; and through that we'll dramatically increase our operating income.

If we look at our results for the second quarter, one of those two levers worked well. Our revenues were up about $53 million, approximately 3%. Unfortunately our productivity lever didn't work real well in the second quarter. Our costs were up about $87 million, about 6% with the resultant impact on the operating income being down $34 million year-over-year. We're not real pleased with those results, and we're taking steps to address the issues that we had here in the second quarter. And as we do that we're looking at everything we do.

Everything is subject to reexamination except for two things, our dedication to service and our dedication to safety. Besides that we're examining everything we do. So if I look at this quarter, first and foremost -- and it's a little painful to admit but we didn't run the railroad real well here in this second quarter, and I like to talk a little bit more about that in a minute-- but first I'd just like to touch on two other issues that did impact us this quarter.

One, as you know, fuel prices continued to stay high. West Texas intermediate has been over $30 for most of the quarter. Year-over-year our fuel price, our fuel price impact on our cost was about $23 million. Our fuel surcharge mechanism did help mitigate that, but it was still up fairly dramatically on a year-over-year basis.

I've mentioned to you before, we have been examining whether we should engage in some hedging activity in order to put more stability into the fuel price element of our cost structure, and we will be engaging in a fuel hedging program that will help us increase that stability in the out years that Oscar will detail for you a little bit more later.

In addition, as you know, we did absorb $17 million in expenses to account for our new asbestos claims in the state of West Virginia. This expense, as you know, is not any admission of fault. It's a correct accounting treatment, and our company will vigorously defend every one of these illegitimate claims because we do believe some of these are illegitimate claims. As you are aware, we did receive approximately 1,500 claims in West Virginia, filed in June a few days before the venue law change in the state of West Virginia was to take effect.

We do applaud the West Virginia legislature for their actions, and we think this will really help us in getting any future claims in the appropriate venue. And then we're glad West Virginia took that action. Unfortunately, West Virginia's only one of 50 states; and the national legislation being proposed on asbestos reform we think is very critical to start bringing some judicial fairness to this process. We'd like to let you know we are actively engaged in helping to promote that legislation and to promote some judicial fairness. Tough issue, and lots of hurdles; but we think it's the way to go.

While those issues did impact us, I think most importantly, we didn't run the railroad at the level we are capable of in the second quarter. We didn't make the productivity gains required to offset the inflation and the volume growth which we set out to do and the reduced network fluidity we experienced really caused a significant increase in some of our labor expenses and some of our other expenses that offset some of those strong revenue gains that we experienced in the quarter.

Failure to resolve these issues and return to the year-over-year improvement in operations and in profitability is not an option for us, so our job and what we're going to do is return to the basics of running our railroad in a disciplined manner, running it to plan. You may recall we did that in 2001 and 2002, and as we did that it had some very favorable benefits to us.

Our service improved which helped us with our modal conversions and our value pricing. Our cost structure got the efficiencies of running a disciplined railroad. That's where we're heading, going back to that same kind of operation.

Obviously that raises the question how did we lose our discipline? We had a pretty good thing going. What happened? Really what happened is, as you know, we've had some weather challenges this year. And one of the things that happened as we were working our way through that weather challenge is we got into the habit, the practice of making a lot of tactical decisions. There were a lot of well-meaning people trying to make decisions to help the operation out, increase the fluidity in the terminal, serve a customer well; and they were making decisions that from their perspective looked to be good ones to help our railroad.

Unfortunately, as you know, railroads are gigantic network operations, and sometimes those tactical decisions really hurt the overall operation of the network. So what we're doing is we're going back to our focus of running to the plan and having the discipline around doing that.

Over the last 30 days we've made some personnel changes and some organizational changes in the operating side of our railroad, and we find we are starting to regain our focus and our discipline. First thing we did is we delayered some of our operations. We accelerated some of the head-count reductions that we had planned to do later in the year into the current period.

We redeployed some people and put more people in first-line supervisor positions directly driving execution of the plan, and we did a process of really doing a job of increasing the clarity around roles and responsibilities. So far we're seeing some encouraging signs, but we're not out of the woods. If you think about velocity that's probably one of the better measures of overall network fluidity.

If we look in the past few weeks, 11 of our 12 divisions -- we have 12 divisions on our railroad -- 11 of our 12 divisions all except for the Atlanta division have improved their velocity versus June; so we're starting to make some progress. But we still lag where we were in 2002. If we look at the first couple of weeks of July, we were running at about 21.3 miles per hour which was 1 1/2 miles slower than same period last year. Most of that is around the Atlanta division.

If you look at the impact of Atlanta alone, it's about one-mile-an-hour of that mile and a half. We got some S.W.A.T. teams, some of our most seasoned professionals down there pulling the Atlanta division apart to figure out what's going on there; and we're comfortable that that's going to rebound as well. We also made a key personnel change. Our southern region is our largest region. It's about 40% of our system and it's our most challenging.

We brought a fellow named Mike Peterson who was running our western region and reassigned him to the southern region. On the western region, Mike had our best performance of all of our five regions in safety, in service and in cost performance; and we're comfortable Mike's going to bring that same leadership to the southern region, our biggest region, and really help us increase the fluidity there.

So overall in operations, we've taken action to restore the discipline. We're encouraged by the results we've seen so far, but there's still a lot to do. Despite these operational challenges, though, we are demonstrating we can grow the business at a sustainable rate.

In the second quarter we hit a milestone. Over the last 2 1/2 years we've now converted over a million truckloads of business back to the railroad. And while we did run an inefficient operation here in the second quarter, we didn't take our eye off of serving the customer and their requirements during that period. So we continue to see our value pricing and our modal conversions having their vibrancy. And as Mike will tell you shortly we're growing the market for rails, getting yield improvements; and we're seeing new volumes from the various new product offerings his team is coming up with. As we improve that operating efficiency, we'll see a lot more of that revenue fall into the bottom line.

I'm going to ask Oscar to take you through the numbers; but before I do, just like to make a few comments about Oscar. I introduced him on our conference call last time -- that Oscar had joined us. To remind you, Oscar came from AT&T where he was the CFO of their consumer services division which is about a $10 billion division of AT&T.

I've worked with Oscar for over two months now, and here's what I can tell you. He has brought a new perspective and fresh ideas to our team, and we hoped he would bring that to the table and he is. He's going to be a tremendous help to us as we examine our productivity issues and think about new initiatives that we can embark upon. Some of you have met Oscar, and those that have -- you can see his energy, you can see his focus; and I think he's really going to be a very positive influence for us. He's going to a good challenging partner that we need in the financial role, so I'm encouraged and pleased to introduce Oscar to you.

Now that I'm embarrassed him, I'll turn the podium over to Oscar Munoz.

Thank you, Michael. Good morning everybody. It is nice to see some friendly, smiling faces.

I'm going to walk through a couple of different things today. Clearly the financials from a consolidated perspective, all the other various components of CSX, as well as a little bit more detail into the surface transportation area. And then, I thought it was important partly for my learning but as well as being able to project some results of some objectives that we've talked about before, primarily staffing levels and some objectives we set out to you -certainly free cash generation and as well as the balance sheet strength or debt levels all in; and I thought that was important to kind of brief everybody through.

Our presentation that we do from a GAAP perspective is not always indicative of what we actually have; so, I thought that was important. So with all that aside let's go through the consolidated information.

I just want to note the first chart, first caveat, 02 has in it CSX lines which was conveyed earlier this year to a Carlyle gain; and, therefore, it creates a bit of an optic with regards to performance. So consolidated revenue was down $131 million, but the loss of CSX L lines over last year masks $53 million revenue increase from surface transportation. Again, we will talk about that in a little bit. Expenses are down 95, same optic obviously, cycling expenses from CSX; but consolidated income of 285, down 36 from last year. The net impact on that 36 from lines is about $6 million just for your information.

Other income up 15, that's the real estate sale that we announced last month; and then interest expense for the quarter of $105 million, down 11, obviously everyone knows the interest rate situation today is driving the majority of that. So net earnings of 127, EPS of 59 versus a reported 63 last year.

And so now if we could, let's dissect the operating income line just a bit more. Surface transportation - operating income was down 34 predominantly due to a lot of things that Michael talked about, certainly our insufficiencies in running the railroad, the asbestos one time thing and, I understand, we also had last year this quarter a contract dispute settlement of about a net $11 million so all of those things added to that; but, again, we'll talk a little bit more about that in a second.

International terminals - our world terminals situation operating income was 17 up just $1 million over last year. A little bit of deeper review of that, $4 million down in revenue offset by expenses. A lot of that revenue was in the eastern or the Asian sector.

Other operating income of $9 million relates predominantly to the minority interest that we have in the terminals, a lot of terminals that we own a minority interest on; so that's the component pieces. So net-net terminals is about $2 million down year over year. On to other income - real estate and resorts up to the real estate sales to triangle and then miscellaneous about $6 million is really interest income, lower cash balances and lower yields on some of the marketable securities. So that's kind of the consolidated look.

And if I could let's go to the surface transportation, the very detailed page here. Let me get the quick highlights. Revenue was up $53 million as you can see on the top, 3% on an increase of about 2% in volume. Mike Giftos will certainly talk a lot more about that in a second, so let me focus on the rest of the chart. If you go down the expense column down to total expense you see the 87 that Mike mentioned earlier. 6% resulting in an operating income of about 259 for surface transportation versus 293 last year. Our operating ratio, or what I am beginning to call more of a reversed margin, certainly declined from 84, declined to 86.3 from 84 last year, a couple of points.

So let's go back up to the expense line item detail there. We have a flash document that you've all received that is very detailed and has all the accounting explanations of what happened line by line. I'm not prone to talk through information you already have. I do want to make a couple of points with regard to some of the line items. Clearly the labor and benefits is one of the largest in the first up there of $22 million.

As Michael said, the staffing reductions and the productivity initiatives that we do have in place just weren't enough to offset some of the operating inefficiencies in the railroad, one. But two, there is a volume aspect to this business, meaning we are generating more volume and more revenue. And that does have some cost, so that's part of the increase as well. And then we have a mark to market on some deferred compensation plans that at the quarter end given the market we had to [inaudible] about $7 million so lots of different components.

As you go down to the next line of MS&L, that is where the asbestos litigation was booked. Offset by a property tax settlement that we had in New York of about 7. So the net number you see there.

The next line - probably inland transportation is the next really big line item. Again, this prior-year contract dispute settlement is in this line over a prior year so we're cycling that so that's driving some of the negative number there. The actual number on this line is 15. We had a net number somewhere else net to 11 but the 15 is there and then an additional issue there, we had running the business there created some other inefficiency.

Depreciation is 10 up over prior. That is not a run rate. You'll ask. We have about $20 to $25 million in depreciation year-over-year; and so some things were prior year and the FAS 143, and the combination of those is creating this optic for this quarter. But full year you can expect 20 to 25, so no concern there. Fuel, as Michael said, the total variance was 24. 23 of it was price. Area, this is impacted not only this sector but, frankly, most of industry. Pricing continues to be relatively high.

We do have the benefit from Mike Giftos's great work on the fuel surcharge which offsets some of this expense from an operating income perspective, but we're also engaging in a fuel hedging program. This is a mechanical approach. We'll buy in 6 to 24 months ahead. It really is a process that will be really structured and controlled. We're targeting an 80% level; and given the forward-looking part of this or the forward part of this, we will be fully hedged kind of in late '05. And so you can just do the math.

You know, I guess if you take 1/18th of 80% starting six to seven months from now -- the beginning of March we'll start getting 4 or 5% per month, ending '04 with probably a 48, 50% number, an average of 24 for the year, and working from there. So other than the math, the story is there that fuel will continue to be something we manage and work through; but, again, we're taking the right steps and, of course, the surcharge is a big component of that for us.

So I step back. My first quarter -- I look at this page as detailed as it is, but, you know, from what I understand from what I hear and read of the work and conversations we've had with you all, we've talked predominantly about two levers. One is revenue and the other is expense management; and, as Michael said, we are doing well on one, and again, Mike Giftos will talk through that. The expenses are our issue. So I'd like to maybe offer kind of a different perspective that you'll see from me rather than just always looking at sort of the detailed P&L version.

The next page as I walk you through this -- this is just a different perspective on the same subject. And P&L's are hard to look at sometimes because they're just absolute numbers. In order to manage and control certain expenses you have to look at them in a way that -- break them down into chunks that are manageable. So, what I did for the quarter really is -- this is just a simple bridge or a waterfall chart, depending on where you're from what you call it; but on the left side you start with the operating expenses from last year. Now, I've taken the liberty of adjusting for that $11 million settlement just so that we just have less stuff on the chart. So you start with the expenses, and you just kind of work from there. Clearly the asbestos thing which is the first one is by all intents and purposes, at least in my analysis, more than likely a one-time charge, not something that's going to recur on a regular basis. Again, a real expense, a real issue for us; but, nevertheless, more than likely one time.

Fuel - we've talked a little bit about that. This is the direct price impact, again, between the hedging and the surcharge program, the OI impact of this over time will be mitigated. And so I think we're making at least the right moves from a long-term perspective, as you look forward in your projections.

The next three items, depreciation, volume, again volume component that I talked about earlier, and, of course, the general inflation and other; and I think you'll forgive me, $12 million on that one five, that's less than 1%, even in deflationary times that we talk about we do have labor contracts and such that increase. So those are the things that we got to work through.

So it's like hey, neat chart, Oscar; but what does it mean? Well, what it means to me is that that circled item is the challenge that we face. There are always going to be things that happen to this business, as I've learn in the short period of time.

But we've got to address and focus on the issues that we know are definitely going to happen. We will have inflation, we will have volume. Clearly with our spending levels and capital we'll have additional depreciation. So those are the things that we've got to attack and those are the things that we've planned to attack. Unfortunately due to what -- some of the things we've talked about, we weren't able to do that this quarter.

So going forward what do we do? Well, our action points, and again it's hard for me to describe these in detail given my limited knowledge; but I'll tell you how I look at them. First is just a general operating improvement and whether it's the delayering, organizational concepts that Al has put together -- whether it's the visible metrics that we're beginning to see, whether it's the dissection of aggregate systemic metrics like velocity for the whole corporation -- You break it down into the component pieces, as Michael alluded to, it does tell a very different picture. It does tell me that we know how to focus and we know where the issues are. Let's go after those. And I think that's very critical when you begin to fix something.

You can't always fix a general systemic average. You can fix things in different places, and I think the Atlanta example is a very good one with regard to that. The other proof point I have behind us is that I have looked at the past and I've looked at the history; and we have been at different levels before, and I think that's important. Having been there, at least mathematically, tells me that we can get there again. So a ways to go, some work to be done; but, nevertheless, a process.

Next, we have, as Michael said, accelerated our staffing reduction that we had planned for the year. I'll talk a little bit in another chart about that; but, again, we had a certain kind of plan with regard to the balance of the year. We've taken a fairly assertive approach given our operational inefficiencies; and again Al Crown has done the bulk of this, and we have accelerated all of those reductions that are predominantly in place right now. And I think that will -- on a go-forward basis will help the network fluidity, operationally, as I understand; but I know what it will do for us is decrease, obviously, our carrying cost or fixed cost relating to the staffing.

And last but not least, and I think where I add, hopefully, some good issues and to something I'll call cost transformation, not so much just general cost take out or productivity kind of things. We have to really think hard, and you heard Michael say that there isn't anything that we're not going to go through. Specifics around this, clearly, I see a great opportunity from a technology and a process perspective of taking kind of our end to end work flow from when a customer orders to when there's payment. I think here's a lot of procedural systematic technology procedures that I think we can make a lot of headway in. We have issues -- so that's one issue.

There's potential issues around outsourcing. Certainly labor efficiencies. We have very, very complicated labor contracts. I think working towards simplification, working closer with our union partners to ensure that we are both productive and leading to a better bottom line for us, and then there are questions with regard to rationalization and things with that nature. And we've been studying those, and the team has been very receptive both from an operational and commercial perspective. I think we're looking hard into those areas. And so those are the kind of things that you'll see from us.

Now, these aren't short term. These aren't tomorrow. We will give and bring specifics and actions around some of these things over the next few quarters; but, again, that's the kind of thought process when I breakdown a quarter that looks at these kind of areas rather than just the financial piece.

So that's kind of a close on the financial aspect, so let me give you the updates that I promised on the initiatives - staffing, free cash and balance sheet strength. I think the headline on this says it all. I think we have issued a number of about 900 for the course of the year. We are going to make that, and we'll make that pretty handily with some of the work that we've just done recently.

The chart - it's hard to read a little bit but generally what it should tell you, what it tells me is two things. One from a slope perspective, over the last three years or so we have reduced staffing in aggregate. The second thing it tells me that, especially in the second, in '02 and '03 there's a seasonality aspect between first and second quarter that should see an increase. That's a normal thing we do. I think we call them gains and maintenance of way sort of work that gets done. But the key and critical number is that on an absolute head count level we are down 451 people year-over-year; and, again, with -- as we report in the third quarter, you'll see that number increase and that number of 900 met.

Next, free cash. Bottom line $94 million for the six months. You won't be able to get the dots to that necessarily on our flash or GAAP statements for lots of different reasons, so let me just walk through it as quickly as I can. The first line cash from operating activities, that excludes the unwinding of our accounts receivable financing program during the quarter and also from a couple quarters ago as well.

From -- if you're thinking from an economic perspective, that's a financing activity; and so it's excluded from free cash. We have replaced that AR financing with on balance sheet debt in -- due to the favorable interest rate environment. So we've removed in the number in this particular calculation -- is 380. Just to make the numbers work and visible.

Cash from operations on the first line is still down $166, a component thing. Certainly our operating income earnings of approximately $35, $40 million is part of that impact. We did make a certain retirement payment to a former executive that impacts that number pretty handily, and then we have some tax payments in that figure that affect that. So capital expenditures on are on plan. Our stated annual goal is what it is. We've not moved off that. We'll certainly make that number.

Other investing activities - that is the cash received from the disposition or the conveyance of our CSX line. Dividends are what they are. And, of course, Conrail cash is coming in; and so that's your 94 down a bit from prior year.

The second objective or one of the objectives we've spoken is with regards to what our free cash might be for '03, we've mentioned the number of 300. I'm still confident that that number will be reached; so that's an expectation of a couple hundred million in the back half of the year, very similar to our cash generation last second half. A little bit higher, but certainly that's what we had last year that we hopefully will not have this year is the New Orleans litigation payment and our capital level spending in the back half will also contribute to that. So, we're confident that the 300 objective will be met for this year.

Then last and certainly not least is our debt. Our balance sheet strength. This is a chart that I like to call -- again, our reporting is not as transparent as you would think. We actually - let's see if I can get this right -- have debt, real debt, that is not on our balance sheet; and we have debt on our balance sheet that's actually not real debt.

So that's the layman's version of it and a financial joke I guess that no one's getting; but thank you. So let's start from the top really. Balance sheet debt has increased by approximately 252. The main reason for this is the net effect of unwinding AR financing and also that we're borrowing back a little more - borrowing money from Conrail which is the second line from that. Again it's a note embedded in our long-term debt that really isn't debt for us. And then moving down to the off balance sheet, you see the huge reduction there. The majority of that being the fact that accounts receivable financing was moved off this line and an additional -- additionally we took the present value of some leases from CS line conveyance that also affected this number. So, again, some movement between line items on this sheet but, again, it's important for you to know where they're all moving to.

Conrail reduced their debt, and that's our 42% portion of it. And then the -- further reduced by obviously the less cash on hand to get the numbers that you see there. So net-net all-in-debt down 259 year-over-year; and shareholders equity -I think this is an important point - increases by 168, and that is obviously a function of increased net earnings or net income during the year.

So, all in, we're now at about a 55 all in debt ratio, down two points from where we were a year ago. I think that's a good point, as I think we've said publicly. 50, "5" "0", is our stated goal for that and clearly a focus that we have.

But our EBITDA coverage - you see a slight improvement there; and to curtail a potential question later that I've heard that might come up with regards to dividends and such, we still firmly believe that our stated goal of increasing cash and reducing our debt, maintaining a strong triple B and, of course, getting to a 50% all in debt is our continued focus, and which we think that's the best thing to do at this point for our shareholders. So I'm feeling really strong with regards to some of the work that we've told you about. Staffing is well in line with what we expected. We'll keep looking at those areas and then move into continued free cash and balance sheet.

Just to finalize real quick, as I look forward, things that we as a corporation and things that I will hopefully help with is -- clearly first is just kind of a financial discipline and rigor. Hopefully the theme of this conversation that I just had, you know, we're going to be about making commitments. And making them. And when we do we'll tell you why. When we don't we'll tell you why; and, more importantly, we'll what we're doing about fixing them.

It really is a bit of a transparent industry. I've been shocked and amazed about how much information you all have on a, frankly, daily basis. It's very different from my old business. So if we're going to be transparent, let's continue to be transparent; and we'll share all our information. The team has their head down and focused on the right things, so I'm excited about that possibility.

Important. But more importantly, the second bullet with regards to all the different initiatives that we have -- I mean, we have great programs in place. I've been very impressed with some of the stuff that one of our executives back at home Fred Fabert is performing with regards to not only six sigma but the PICT process of improvement. I think we've had some good teaming efforts around them, and I think that is going to pay off. Again not a short-term issue but, nevertoeless, that program as well.

In addition to those initiatives some of the things I mentioned before we'll continue to bring to you; and, again more importantly, around all these things when we say PICT or six sigma or whatever it is, I want to start bringing what I call proof points. And that's just a basic, simple concept that says when I say, when Michael says, when Al, Ed, or when anybody in our organization says something, there's something fundamentally specific and quantifiable that you guys can latch on to that says I think that makes sense; and then we'll continue to prove that we can measure ourselves against that. So that's where we're headed.

The last thing on revenue is -- that's another lever that we have. I'm, frankly, staying away from it. It's looking good. Mike's doing a terrific job with it, and he's going to tell you all about it. So, Mike?

Thank you, Oscar. And, again, welcome to this second-quarter earnings release.

In the second quarter we continued to operate in a challenging economic environment. You're all aware of that. We continue in an environment of economic uncertainty, but we also continue our focus on yield. We also continue our focus on modal conversion. And with those, even in this environment, we enjoyed a year-over-year revenue growth of about 3%, some $53 million. And we continued to see the yield improvement that I've been showing you in the past several quarters. Overall for the company we achieved that 3% growth on about 2% carload growth, with revenue per car yield improvement for the entire organization of about 1%. And you'll see as we move through the various commodity sectors some of the yield improvements were significantly better than that.

We achieved these yield improvements through a variety of things. Of course, we had our fuel surcharge program that's reflected in there. That's some $17 million of revenue we've collected this quarter from that program. That's 15 more than we collected last year. We had some mix impact; but, importantly, we had our continued focus which we will continue on price as well. All commodity groups with the exception of our auto group showed year-over-year improvement in operating revenues.

Let's look at the auto sector first. This is the first time after five consecutive quarters that the auto group did not improve its year-over-year revenues. The revenues were down $3%, $7 million. Carloads were down 6%, and the yield, the revenue per car, improved 3.3%. I think we all know it drove that year-over-year volume decline. Production declined to 4.24 million units in the second quarter, down 9% from where they were the year before. That's the lowest level that we've seen in the second quarter production since 1998.

The auto producers continue to focus on incentives. The production in sales continue to exceed my expectations. This is an area that we'll watch carefully as we move through the year; and we hope the incentives continue, the economy picks up and we see an improvement in auto sales as we move through the year.

We told you last time that we expected our coal revenues to improve in the quarter, and they did. And this is after five - five consecutive quarters of revenue decline. Our coal revenues were up 4.3%, some $17 million on an increase of 2.2% in carloads with yields improving about 2% as well. Largely driven by increased volume, increased sales, now utility market, the utility business at CSX represents about 70% of our coal sales.

Our northern utility business was up 16% or $20 million. Our southern utility business was up 12% or $18 million. The strength of the utility market was offset by declines, some weakness in our export traffic, our industrial traffic, our coal, coke and iron ore businesses - excuse me, the coke and iron ore businesses - as well as our river traffic. Those offset the terrific performance in our utility market. We expect this performance to continue as we move through the year.

We have some interesting conflicting signals out there on the one hand: we've seen exceptionally cool weather in the eastern part of the United States for the last several months. Electricity generation east of the Mississippi river in the month of June was down 7% from a year ago. In the early part of July, we see similar declines in electricity generation.

Nevertheless with gas prices at historic highs, as long as we produce some electricity we're confident that coal will get more than its fair share, and we're confident that we'll see the continue replenishment of stockpiles. And if we can return to more seasonable - more normal weather, coal could do quite well.

Let's look at our merchandise sector. Merchandise had -- this is its fifth consecutive quarter of year-over-year revenue growth - year-over-year growth that's occurred in an anemic economy. Revenue is up almost 4% or 1.3% growth in carloads, as yield showed a nice improvement of 2.6%. With the exception of our chemical business, where the revenue was essentially flat on a 4% decline in carload, all other commodity sectors enjoyed year-over-year revenue growth.

Let's look at a couple of those. The metal business was up 8% on carload growth of about 8%. Sheet steel continues to be strong as we continue to enjoy significant modal conversions in that area and continue to benefit from some exports in that area. Our forest and industrial products business was up $10 million or 5% on essentially flat car loads. Building products remain strong in response to the strong housing industry.

News print and our other print business is strong, more than offsetting some continued weakness we see in the important brown paper sector. Our chemicals business, as I indicated earlier, was essentially flat. We know what's going on there. That's perhaps one of the better barometers of the over all the economic activity in the country. We continue to see very very high feed-stock costs that are driving lean inventories in the chemical sector. We need a little bit of uptick in the economy and reduction in some of those feed stock costs to get that sector moving in the direction we would all like.

Our emerging market group had a terrific quarter again, up some 10% in total revenue, $11 million, 10% increase in revenue on an 8% increase in carloads.

In the first quarter what really drove the growth in the emerging market area was the exceptional military moves. They're up $17 million year-over-year in the first quarter. Again, a nice pickup at only $4 million this quarter. What really was driving the growth in that sector - we expect it to continue perform well - is the growth in our waste business, the growth in our aggregate business and possibly with some additional return of some of that military cargo we could have a terrific plus in that in the second - in the third quarter as well.

Our intermodal sector - its fifth consecutive quarter of nice year-over-year revenue gains up some 6% on 5% volume growth. The second quarter was a challenging quarter in the intermodal sector in the sense that last year, as you may recall, there was a terrific amount of pre shipping in anticipation of the west coast labor strike. The volume gains that we've been averaging over the last several quarters in intermodal have been closer to 9%, and if it wasn't for that west coast anticipated labor strike I think we would have seen that same type of behavior in performance this past quarter. Tough comparisons.

In the domestic market, it was up some 14% in revenue or $24 million on a 9.5% increase in carloads. The domestic market has been -- performance was driven by an increase in the number of CSX u 53 ft. containers that we added to our fleet.

The terrific load board activity - that's that marketing initiative that we talked about a year ago, we're now averaging about 1,000 units a week that we're achieving off the load board; and we expect that number to increase. That accounted of $10 million year-over-year revenue improvement in the domestic sector. The domestic sector was also positively impacted by a growing trend of transloading the international 40 foot boxes into the 53 foot containers. So we saw some transloading that also contributed to the growth in the domestic sector.

As we move to the international sector, we see that our revenue is down about $3 million on volume that's up. What's going on there? Well, again, that transloading of the international box into the domestic sector is clearly reflected in these numbers. Additionally we've seen some all water diversions to east coast ports following last year. The change in mix is largely a function of two things. We had a significant decrease because of that transloading in our loaded volume. Loads were down 7%, carrying an average revenue per car of $457, while empties were up 9% and carry an average revenue per empty of $225. So the mix effect contributed to the decline in revenue per car in the international sector.

As is customary we have our forward looking slide where I share with you how we see our markets performing as we go forward, and it's an interesting mix. We see that our auto sector, I have that in the unfavorable category. It's only partially there, just slightly there. We expect second -- we expect third quarter production to be down about 3%. That can change as incentives kick in and customers start buying more; but what we see today based upon production levels, we expect our year-over-year performance moving forward for the foreseeable future to be slightly unfavorable.

The chemical sector I also have in the unfavorable category for all the reasons that I explained to you earlier. High feed stock cost coupled with relatively weak economies lead me to believe that with we're going to continue to look at chemical traffic in the unfavorable category for the foreseeable future.

As we move into the flat categories; two of them. Metals and phos and fert (ph). Phos and fert - let's talk about that first. As you recall, last year a terrific year in that commodity sector, a banner year; and I think replicating that would just be a terrific accomplish. The Bone Valley last year, our phosphate territory, was operating at 97% of capacity. It's doing very well now, and I think a flat performance is what I expect there.

The metals business, well, I think we'll continue to see healthy modal conversions. I think we'll see some strength in our pipe business. But I'm worried about the auto sector and the important contribution that the metals industry provides to that sector, so we see that at the flat line at this point in time. In the favorable area we have five commodities. We have our coal business for all the reasons I've explained to you earlier. First of all, we have some fairly easy year-over-year comparisons. We have historic high gas prices. We expect some to continue to replenish inventories. The weather is a concern. This weather has been exceptionally mild, but I still believe we'll be looking at some overall year-over-year strength from the coal sector.

Our intermodal business - continued strength in that domestic product with modal conversions. I expect that will continue to perform as it has for the past several quarters. Same with emerging markets, the strength of our waste business which has been growing quite nicely, the aggregates business particularly in the south and with some possible assist from the returning military cargo that we shipped over there in the earlier part of this year. That could perform very, very nicely.

Our forest and industrial sector is doing quite well; and I expect that to continue, with strength in our news print and other printing products and building materials more than off setting any weakness we see in the brown paper area. And our agriculture and food product lines are all doing quite well. Food areas enjoying significant modal conversion, refrigerated products with the Union Pacific express lane project growing at a 7% rate. A stronger harvest, compared against some relatively weak comparisons a year ago leave me encouraged in that sector as well.

So in conclusion, I'm cautiously optimistic about what we're facing. Cautiously optimistic. Concerned about the direction of the economy. But even if the economy continues in this sideways movement we've been experiencing in the past, I think we can do quite well.

I think we can continue to take trucks off the highway, and I'm encouraged. We know our coal business is strengthening versus last year. You can be assured that we'll continue our focus on yield as well as modal conversion. And with truckers facing exceptionally high costs, high costs with respect to insurance, with respect to drivers, with some new federal regulations affecting emission controls and their capital structure, the rail/truck comparison in economics is favoring railroads; and that will certainly help us with our improved service to gain modal conversions. So if the second half recovery that we expected last year and the second half recovery that we expected the year before that should occur, my cautious optimism could really become quite optimistic; and I look forward to your questions, thank you.

Thank you, Michael.

As you can see from Mike's forward-looking slides we see some good growth possibilities in several of our markets, a few a little bit challenged. And I think the economy - just to add one thing to Michael's comments - we don't know what it is going to be. But what we do know is that we've been able to sustain growth greater than GDP and industrial production growth; and we expect to continue to be able to do that regardless of what the economy is. Fuel will still be a challenge going forward. Amazingly prices hang up in that 30, 31 range so that could be a challenge for us going forward.

On the operations side, I'm feeling good that over the next couple quarters we will get back to the kind of service, the kind of discipline and cost structure we saw in 2001 and 2002. We've done it before. We know how to do it and it's just a matter of us executing it. And I think we're on the right path. More to do, but we're on the right path.

As Oscar showed you we had that $35 million, $36 million worth of not offsetting some of our inflationary cost, our volume cost that we think we can do on a sustained basis. Running the planis going to help that; but in addition we're going to have to be challenging our current practices, examining everything we do, employing technology to increase the productivity over what we produced here in the second quarter.

With that I'd like to open up for questions and answers. I would ask before you start your question if you would please identify yourself and your affiliation please. Tom.?

Hi, it's Tom Water from Berwick Stearns. Two questions for you here.

One that you mentioned Atlanta was an issue, and I wonder if you can give me a little background. What caused the issue to start in Atlanta? Was there a specific weather issue there? Was there a change in volume mix and maybe give us a further sense of at least initially what you're seeing that you think needs to change there?

I'll be glad to address that. I'd like to ask Al Crown our Chief Operating Officer if he could address that please.

Tom, it's probably a little bit of all of that. We've had some pretty severe rains, and we've had some lightning strikes and tornadoes. It's started out; but clearly one of our problems is around the management that we had down there, so making these changes in the management we think will move it faster ahead.

As it got into tactical, they truly kept going that way and instead of grabbing the bull and going back to plan, they kept being tactical. We're working on some infrastructure things around the tracks. The tracks are absolutely safe; but after all of this rain we lost a lot of the momentum we had put into the tracks, so we've got some extra people out there working so we can get the speed up between our terminals. Our two big terminals down there have a lot of work to do around them, and we've got people in place to do that.

Okay. In terms of mix, has mix been big effect in terms of network operation or is that not really --

I haven't seen mix being an effect on network operations. Clearly, we've got some more business; but I don't see it as a big change.

Okay. One for Mike Giftos, if I can here. The effect on pricing or on TL conversions given that the service hasn't been quite where you want it to be and just also with the idea you've been in a pretty strong pricing story for a while, is that slowing down at all or do you still feel confident you'll get the pricing gains you're looking for?

Let me take the first question first, if I may. One of the things that we've done, one of the things you've heard from both Al and Michael, we've spent a lot of money in the first and second quarter on our operations to in part keep our service levels from our customer perspective as high as we possibly could.

So we didn't compromise cost and service perhaps as we move forward and our operations get better we certainly expect our cost to come out. So from our customers' perspective our service hasn't been as bad as the operations have been from our internal perspective.

Some of our time sensitive customers have clearly experienced the effects of some of our service challenges more than others, but the vast majority of them have not experienced significant deterioration in service. So I remain very optimistic that we'll be continue to be able to enjoy modal conversions because I'm equally optimistic that the quality of our service is going to improve.

With respect to the pricing question, you can be assured that I remain convinced that we can continue to enjoy price increases as we move forward. I think the comparative truck/rail economics are quite favorable. I think the value proposition that we have today will allow us to continue to achieve price increases.

As I've said in the past, I'd like the economy to improve. I'd like some of my customers to being doing a little better, so it would not be quite so painful. But on the whole I think that while it has slowed down, I think I told everybody earlier in the year that our price plan for the year is around $100 million, and we're tracking actually better than that. That's compared with 150 for the prior two years. I think we can continue to stay at that level even in this economic environment.

In terms of head count reduction, Oscar, I think you said 900, and I thought you said you'd be done by the end of the third quarter. Did I interpret that correctly?

It's a full year number by 900, but with accelerated parts of it to insure that we make that.

And can you give us a feel for - I forgot, maybe you already did this when you put out the original release on this, but is this both white collar and blue collar or just white collar, the 900 people?

It's a combination of both.

And Oscar, I don't know if it's for you or Michael, when you think through your velocity and other service metrics and operating metrics that would have been much better back in 2001, you look at where you are now, is there any way to try to quantify what your cost would have been or how much savings you would have you would have had in the second quarter had you run more efficiently?

That's a tough question to answer. Those are complicated network issues. Actually we're running below our levels of 2002. I think we're actually still above what we were doing in 2001 in most of the key measures.

Okay.

But I would say that the $35 million that Oscar had up there, because as you know part of what we set out to do is we would increase our productivity to offset both the volume and the inflation and, by and large, we were doing that; so I'd say a minimum of that is that $35 million. The quantifying that exactly and telling you how to precisely do that I don't think we could, but I'd say it was in the 35 to $40 million range.

For Mike, coal pricing, do you have a feel for, are there any contracts that have come up here recently or any of those that will be coming up between now and year end, and your sense of the rail to water competition bids?

In the second quarter of this year we had no contracts up for renewal. In the last quarter of this year we'll have about $430 million worth of business up for renewal, so the second quarter I don't have any percentages to share with you.

I expect we'll continue to be able to enjoy nice increases in those contracts. Perhaps not as high as the near double-digit increases we achieved last year, but I'm aspiring to something north of 5%.

Scott. Could you identify yourself, please?

Scott Barr with Salomon Smith Barney. A couple of questions for Mike and then one for Oscar. Mike, I was wondering in the core, can you give us some sense - and I know you said there were mix effects - but how much did mix do you think affect your pricing? The RPU is not a perfect measure of pricing, but I'm just trying to - and then I've got a follow-on question after that.

That is a tough one to break out specifically but I think we achieved our goal in the second quarter of achieving about $31 million of increased revenue from price. So when you look at the price effect on the total revenue, there's $31 million in there from new price.

If I look at the total yield change, I think about a third of it is mix and about a third to a half is price.

Okay because the reason I want to ask that is if I take out the $17 million less the $2 million last year in surcharge and just run it against the average loads it's basically up three basis points. And so that's why I was asking about mix effect versus price versus -- because obviously if you look at that superficially it doesn't look as if pricing is quite is a good, if I strip out the fuel surcharge.

If you strip out the fuel surcharge -- you obviously have to look by commodity area.

Right. And then I guess the other quick question, if I look at equipment rentals and I look in the flash it talks about renegotiating car hire rates. Is that sustainable as change - because I guess why I ask that question is obviously the ops weren't where you want them to be, the velocity wasn't where you want it to be and equipment rents dropped. So I guess what I wanted to get a sense of was were the renegotiations on those car hire rates on a going forward basis or were there catch ups?

Basically going forward, Scott, we renegotiated a number of our car hire agreements that will continue, I think in future quarters to to produce favorability. I think there was a small element of reclaims in there, but 50% to 60% of it was actual renegotiation of rates that will go forward.

Okay, so then 30 or 40% was actual recapture from earlier in the year?

Right. Gary? Id please.

First Boston, Credit Suisse First Boston. Garry Amblon. Mike, I wanted to ask you if you could update us a little bit on some long term goals. You've talk in the past about where you'd like operating ratio to get to. It's not gotten there. Can you give us a sense of what you're thinking and to follow on the second question, also for you, how much latitude does Oscar have to do whatever he needs to do?

Those are two good and challenging questions, Gary.

To deal with the first one first, as you know we stated I guess it was about a year and a half ago we thought by 2004 we could grow the revenues roughly a billion, keep the costs flat and produce an 80% operating ratio. We did put some caveats around that. That fuel price stayed reasonably, that we got the ever receding bonanza of an economic recovery which Mike alluded to earlier so that clearly achieving that 80 in the '04 horizon is not a realistic goal at this point given where the economy is, given where fuel prices are.

I would say - and then I'm a little hesitant to exactly calibrate here - but I think that's probably at least an '05 target now, and what we hope to do - and Oscar mentioned proof points to you - what we want to be able to do, we have shown some good evidence that we can grow our revenue and we think that is sustainable. We also, though, know we need to put some additional productivity ideas on the table. We've got our ROLC's, our APU's, our [inaudible] recording. Those will all help us, but we need to come up with additional ideas. As we come up with those proof points and quantify what those are worth, we'll probably be able to give you a better gauge on that, Gary.

So I would say within the next couple of quarters we'll probably be able to set more realistic targets for where we'd be. But we do still believe we can get to 80% and we think we can continue to show good several points improvement year-over-year and some of it will depend on the economy, the fuel; and we will come up with some additional productivity ideas.

On your second question of Oscar's latitude, I think Oscar going to have a lot of latitude. With all due respect, he has got some learning to do. This is a complicated business, and he has some network-based knowledge with his telecommunications background. So he's got a little learning to do, and he's learning quickly. But we invited Oscar in because we wanted to get some fresh ideas and challenging perspectives - and I don't think Al would mind me quoting him on in this - he said, "The more I see Oscar, the more I like him; and I can tell over time I am going to love him and hate him." And that's the way a relationship should be of a good challenging partner. So clearly we're going to give Oscar a lot of room to be a good challenging partner with us. We are going to bring some knowledge he doesn't have, and the combination of the two are going to produce some pretty good results for our shareholders.

Thank you.

John Barnes with Deutsche Banc. Mike can you comment briefly on where you see coal inventories on the CSX system? And secondly, given the amount of rain we had in the spring and the beginning of the summer, some of the rivers in the eastern U.S. are a little bit unsafe for barge traffic have you been able to pick up any market share from barge?

We think inventories are pretty close to where they should be, where we'd expect them to be at target levels, maybe slightly up in the northern part of our network. So the inventories are in pretty good shape as best we can tell.

We're constantly looking at barge competitive traffic; and we've had a number of modal conversion initiatives, some of which I've talked about in the past offsetting some of those structural losses that I shared with you earlier in the year serving a number of utilities that previously received their traffic by the river system or by truck delivery. So we're constantly looking at those and making some terrific progress, and it's been important to us.

Thank you and then Michael, it was about this time a year ago you began to run into some infrastructure issues with heat and that type of thing. And going in to the latter part of the summer, is there anything you're doing on a proactive basis to prepare for that; and should we see system velocity while improved over a year ago should it stay constant with these levels or maybe even trend down a little bit with those proactive efforts?

I can address that; but I'd like Al Crown to address that if he could, please.

John, we've changed the way we do heat orders. We now look at the specific locations and limit the amount of railroad that we slow down. Can you hear it okay? And that makes it just as safe; but it keeps trains running at a higher velocity, so we shouldn't see those kind of problems that we had before.

It was last year when we had the heat orders we would take a whole division out which, obviously, had a pretty dramatic impact. And we've developed over the winter a way of doing that on a more pinpoint basis, so we can really highlight the places that are at risk of derailments or sunk-ins. So we think it won't be nearly as disruptive an issue. And in addition, as you know we've been putting some pretty good money into our track structure; so it's stronger track structure out there. So I don't think it'll be a big issue for us, John, this third quarter.

Thanks.

I want to come back to Mike.

Identify yourself, please.

Jeff Clough from Fulcrum Global Partners.

Thank you.

Mike, I want to come back to Scott Barr's question on pricing. You mentioned the $31 million increase in pricing. Let me slice it a different way. You were up about 1% on revenue per car. About 1% was the fuel surcharge. I'm going to guess roughly a third of your business is tied to RCAPs, and I'd ask you in the question to let me know what that number is. That is up 2 to 3%, and so you've got another few percent that way. If I do the math it basically implies outside of RCAP, outside of fuel surcharge, pricing went down, revenue per unit went down. Auto and chemical are weak; intermodal and coal are strong. I realize there's a mix issue, but I am going to guess that it's not more than a hundred bases points; so the implication is you're not raising prices more than 1% on the rest of your business. Why is that so, and is that a fair assessment?

I'd be very careful about averaging averages, but let's look -- let me answer your RCAP question first. About 20% of our business is subject to RCAP, a smaller percent. And even there, the percent subject to RCAP, we have a number of our RCAP's that are capped at a certain percent. So it is something that we've been working on fixing because I don't like RCAPs that are capped. And at CSX we have a policy that we'll either have a fuel surcharge or an index that captures fuel, and we'll be satisfied if RCAP is at 80%. And that's a policy that we put in place three years ago. So about 20% of our business is subject to RCAPs. You have to look at our individual commodity sectors to get a better understanding of the pricing picture. If you look at our coal business, revenue per car was up 1.9% to $19 million. It's easier to dissect coal than it is the entire merchandise network with mix changes. Out of that $19 million, $7 of it was mix, $2 of it was fuel surcharge and $12 of it was price - price from contracts carried forward and the modest amount of that business is subject to RCAP.

If you start getting into our other individual lines what I do - and it's tough measuring the precise impact of price in each commodity area - but I get a constant contract review presented to me in the second quarter. The contracts and merchandise that came up for renewal averaged a 2.8% price increase.

And so it's information like that coupled with those of you who know me, my uncompromising focus on price that gives me an awful lot of confidence that we're not going to lose our focus on it. We will continue to get pricing.

That's what I wanted to hear, thanks.

Thanks, Mike. Ken Exter from Merrill Lynch. To follow up on chemicals business, you started off by talking about how we're seeing a little bit of weakness in that right now, and you expect that going forward. What are the trends that you're seeing there? Is there something specific? And just a quick one for Oscar. When do you, I'm sorry, when do you guys expect the Conrail break up with the folks that are on the income statement?

Chemicals, chemicals in one of our commodity areas that most closely mirrors the overall economic activity of the economy. So with a sideways economy coupled with extremely high feed stock prices, propane and it's very, very high, natural gas prices are in excess of five dollars and [inaudible]; so production levels are being kept very, very low - not only in response to weak demand but an obvious desire not to build up inventory.

In fact, we've seen in the United States this past year significant increases in imported plastics, something that hadn't occurred in prior years as producers in the Middle East are able to produce with much lower feed-stock cost. So what we need to have happen in the chemical sector in my opinion is we need some strength in the economy. We need the basic feed-stock cost to come more into balance before we see a pickup there.

On your other question perhaps it's more appropriate if I answer that, Ken, than Oscar. I'm more familiar with some of the history around that. As you know, we've applied to both the service transportation board and to the Internal Revenue Service for spin of our -- basically a tax-free spin of the assets we and Norfolk Southern now lease from Conrail to us as the shareholders of Conrail. And there's really three critical elements there. We need STB approval. I don't anticipate that being a huge issue because we're not changing any of the commercial access that our customers have and which is really I think the main thing the STB would be focused on. But that's likely to be a six to nine month process; and, obviously, we're a little bit challenged that we only have one commissioner on a three person commission at this point. So we'd expect that to be a six to nine month process. Secondly, we need to get an internal revenue service review; and that probably is also a six to nine month process. We need to get consent from Conrail debt holders at this point. So we've got three critical elements within there. Without any one of those, we're not going forward. One of the main benefits of this transaction is really better operational and financial transparency of our results.

You know, as Oscar had to lead you through today understanding where our debt is and what's real debt and what's sort of not real debt and where's the cash flows, I think it will give us better transparency and I think it will give us better transparency in our operations; but I don't think it's a huge, if you will, economic difference. So we think it's a good thing to do, but we won't proceed unless we get the approvals of all three. So we're probably looking at if you figure there's going to be longer lead times, at least a nine month process to get all three parties in sync.

Mike, question. Tony Hatch has a question for Mike Giftos. You were excited or at least optimistic about intermodal, and you mentioned domestic. But we're coming in pretty soon into the peak season. I just wanted to know what you thought that would be in a year-over-year basis, given all the things that happened last year. And then also if you could just quickly give a net new business number. You used to give that in the past. Given the new products and stuff, what is the net number for new business?

Sure. We're optimistic with respect to both the international and the domestic sector as we move forward in the intermodal area. The transloading activity which tends to understate -- cause the international numbers to be understated will continue, so it's a little bit hard to predict that. We've seen some volume that's been fairly light on the west coast recently. But the year-over-year comparisons as we move into the second half should be a little bit easier because of the strength related activity.

How you add that all up and come up with a number as precise as you want is probably a little too challenging for me now, and I am disinclined to do that; but I think we'll see very nice intermodal pick up year-over-year along the lines we've been seeing in the past, in part because of our modal conversions that we've enjoyed, the continued success of that load board trucking initiative, the new product CSX introduced about a year and a half ago. It'll continue to drive additional volume growth and also the new containers, the new 50 foot, three foot containers, some 2,000 of them versus a year ago that we've introduced into the marketplace, all of which we are turning at very, very attractive rates.

Your second question was the modal conversions. The modal conversions - net new business from modal conversions in merchandise is $22 million in the second quarter. Intermodal, I tend to think of all that as modal conversions, new business. So if you think about the total merchandise sector as $22 million worth of revenue, that's the net number in the merchandise sector. And you can see the intermodal number is essentially all new business.

So, with that I would like to thank you, again for your attendance today and your interest in our corporation. Thank you very much.