CSX Corp (CSX) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the CSX Corporation second quarter earnings release conference call. All participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session at that time, if you have a question, press the one followed by the four on your telephone. As a reminder, this conference is being regarded, Wednesday, July 28, 2004.

I will like to turn the conference over to Mr. David Baggs, Assistant Vice-President, capital markets.

Welcome to CSX's earnings presentation. Before we get started this morning, I wanted to remind you that during the course of the presentation and the question-and-answer session there may be forward-looking statements contained in our remarks. And it is important to remember that these forward-looking statements may vary materially with what actually happens in the future.

With that, I will turn the presentation over to Michael Ward, Chairman, President, and CEO of CSX Corporation.

Good morning and thank you for joining us at CSX's second quarter earnings call. With me today are three members of our leadership team -- Tony Ingram, our Chief Operating Officer; Clarence Gooden, our Senior Vice President of the Merchandise Service Group; and Oscar Munoz, our Chief Financial Officer.

By now you have had a chance to review our press release. Oscar will go over the results of these in greater detail, but I want to highlight a few of the numbers. For the second quarter, we reported net earnings of $119 million or 55 cents per share versus $127 million or 59 cents per share a year ago. This number does include an after tax charge of $9 million related to the company's now completed management restructuring initiatives. Excluding the charge, our second quarter net earnings would have been $128 million or 60 cents per share. Our service transportation units reported a 14% improvement in operating income excluding the charge and a 1.1 basis point improvement in our operating ratio despite our operating challenges. These results are our second consecutive quarter of year-over-year earnings growth.

On the revenue front, our service transportation units showed increase in both record and volume. Volume increased 3% and revenues grew 6% over the same period last year. More importantly, this is the third quarter in a row that we delivered record setting revenue levels, reflecting the results Clarence and his team are producing during this period of economic growth and high transportation demand. This growth was across nearly all of our markets. In the quarter, merchandise revenue was up 7% year-over-year, led by strong gains in chemicals, metals and emerging markets. Pro revenue was up 6% and intermodal up 4. Many of our markets, especially metals and coal are seeing the effects of a booming Chinese economy as that country continues to place strong demands on raw materials around the world producing tight supply and ships in sourcing of key commodities.

I'm pleased to report that we continue to have success in our value pricing and yield management efforts. These are key components of our revenue growth strategy. Overall, our revenue growth was in line with the leading indicators that showed a 4 to 6% increase in economic growth for the period. In addition, the U.S. Department of Transportation has reported that its transportation services index is at an all-time high, reflecting the sharp, steep increase in demand for freight services and the demands being placed on our system. This drive will need more resources, locomotives, crews, and cars at CSX and across the railroad industry.

In this robust economic environment, our revenues are growing. However, the volume growth is lower than it could have been, given the inefficiencies that we have in our operations. During the quarter network fluidity was challenged as velocity declined as terminal and car load increased. Two measures key to our customers -- one-time originations and arrivals declined. Not only are we not meeting all of our customer's expectations, the inefficiencies in our operations generated costs that were too high. Simply put, we aren't where we need to be. However, we are taking steps to reverse this trend and to maximize the full leverage of our system long term. The CSX One Plan, our network redesign, is the next step in that process. Tony and his team have been rolling out the new operating plan, and we are on schedule to complete that rollout in advance of the fall peak. The One Plan provides a framework to drive an improvement in our service quality and increase in our capacity through increased asset utilization and improved network fluidity gradually over the next several quarters. While we are encouraged by some of the initial results, we still have a way to go to rebuild the reliability, consistency, and discipline required to produce the continuous and consistent improvement that our customers and our shareholders require.

In addition to our One Plan rollout, we are adding locomotives and crews to prepare for the fall peak, as Tony will discuss shortly. One other improvement effort that we have implemented is our management restructuring effort that we launched in the fourth quarter of 2003. As you know, we achieved our stamping reduction target of 900 positions and significantly streamlined our organization. Obviously, this will improve our cost. But I'm also excited about the progress we have seen with the increasing accountability at CSX, which will continue to grow as we change our culture to one of discipline and accountability. These efforts are driven on a daily basis to give our customers what they deserve and financial results each of us expect. And while I'm pleased with the focus and the energy of our organization, we must do better in delivering operating improvements and efficiencies that will come with that. CSX's value creation potential will only begin to be realized when our operations achieve the kind of improvement trends we achieved in 2001 and 2002. Once we reach those levels, we will continue to push for more improvement. Obviously, such a turn around does not happen overnight. It does happen as a result of our focus on discipline and process driven efforts that we are pushing.

With that, I would like to turn it over to Tony Ingram, our Chief Operating Officer, to talk more specifically about our operating efforts.

Thank you and good morning. As most of you probably remember at the first quarter earnings call, I told you I was going to focus on two areas -- safety and on-time origination. We are bringing focus to both areas, and I will talk about each area in a moment. Since joining CSX, I have made several trips to our field operations, and these trips have targeted many of our large operations and our large shops. We use these trips to take the message to our employees and labor leaders. More important than these trips, we are listening to labor and getting their feedback.

Let's look at key operating metrics there on your slide five. As this slide shows, we are making some progress in both personal injuries and train accident frequencies. The personal injuries show small improvements, and the train accident frequency shows slight improvement year over year, but we were proud of the improvements that we are making. While our human factor remains our largest challenge, I am pleased to report that year-to-date industry numbers, that CSX has the lowest track in the equipment frequency call derailments. To try to continue and strengthen improvement in our safety performance, we are focusing on using our safety leadership and our trained accident prevention processes that we use to improve our safety in 2001 and 2002. We are looking to these same efforts to deliver safety improvements in the 2004 year.

On the operating side, the origination in other key operating measures deteriorated in the second quarter. This reflects a network challenge and our inability to restore fluidity on a demanding surge in the second quarter. But following the second quarter in our early days -- following the holiday of July 4, our operating metrics have improved. We reached a 21 mile per hour velocity, cars online fell down below 233,000, and our origination has reached almost 70%. And we are looking at how to improve the fluidity of our network.

Turning to the next slide, number six, steps are being taken to improve the fluidity of our network. We are handling record volumes that exceeded our forecast. However, after a congested May and June, we have improved greatly, and you are seeing those in the most recent public numbers on the pages. We used the July 4 holiday to clean up our system and restart our railroad. This was a structured effort allowing us to catch up during a period of low volume. Our goal was to clean out our terminals and get current and get ready for the implementation of our One Plan as we continue to grow and greatly improve. While these efforts are working, we are facing the biggest fall peak on record. I still believe the improvements will continue, but will not be as sharp as we saw cleaning up after the holiday slowdown.

In preparation for expected continuous demand, we are adding resources to our system. 100 to 155 new and lease locomotives will come online this month and the following month, and we were targeting to handle hiring over 1400 new employees this year, approximately 25 to 30% better than attrition. We are also looking to step up our 2005 hiring in the late November and December. At the same time, our long term improvements efforts the CSX One Plan is on track. One Plan is our network redesigned efforts to improve the efficiency of our operation.

Let's move to the One Plan which we outlined in two pages, and I will talk about Phase One on page seven. Phase One takes a clean sheet approach to building a plan for trains across our system between our major yards and terminals. It's a quick hit. It's designed to utilize the existing infrastructure of the yards. It does not consider the rationalization of the expanding of the yards and doesn't alter the local delivery process, which we will discuss in Phase two. Simply stated, the goals of Phase One is a plan that is efficient, minimizes car miles and intermediate car handlings, balances our resources, that's true in power, and most of all can be executed. In building this new plan we engage in both still operation and service design to develop a plan that is efficient and deliverable. We are confident that we have a better, more efficient plan for our batch network. I view that One Plan implementation has an opportunity to get our railroad back on a more discipline operation. The Phase Two that I briefly mentioned will address the local delivery. It will improve the efficiency and asset utilization and look at our physical plan. Phase Two studies are under way, but findings will not be implemented until the following -- at the end of the year in 2005, following the fourth quarter. Then in our first phase focus you will see it outlined on slide eight, the One Plan addresses only our batch network, which is the merchandise auto parts and finished vehicles segment of our business. Over half of 2003 carloads moved in this batch network, generating half of our line haul revenue.

The remainder of our traffic moves in what we call our intermodal network, or unit train, such as grain, coal and rock. The batch network represents a disproportionate number of car miles and also intermediate handling in yards. 60% of our car miles fall in this category, and nearly 90% of our intermediate handling falls in this category. Improving our execution and batch network is the primary driver of overall improvement and service and efficiency and that's where the first phase of our One Plan is focused. However, because our route and key resources are shared by all of our trains and are tied together, the fluidity of the batch network impacts the performance of the other network such as the coal, grain and rock that I mentioned. Stated another way, running the batch network to plan is critical for overall service and efficiencies.

In the next four slides starting with slide nine, I will show you the main elements of how they will be implemented the One Plan. In ASP, the the Annapolis is the yard called Avon. The first implementation. It was a small implementation that we performed on July 24 and is now completed. This is also focused on the traffic that flows to the St. Louis gateway, a major interchange location with the western carriers. While we had a few setbacks, our early reserves are very promising. After four weeks performance in our metrics, this area is much improved by all examples. For example, our on-time originations are consistently above 80% mark, even at the time when -- we installed this, we had heavy volumes there in June. However, this was the relatively small implementation for our rollout. Our largest portion of our implementation of the One Plan was Mid West and automotive network as outlined on your page 10. We actually completed this on July 21, and had a significant improvement in this multiple yard system. We also made implemented changes across the entire network, which encompassed our auto network and trains originated in the midwest area where there is a lot of automobile traffic. One significant change we made was by us moving all multi level traffic out of the Cincinnati yard to Louisville and built our outbound trains for automobile. This allows Cincinnati to increase other traffic. This was a good test for our data system as we loaded up our new profile for our trains.

At mid August, actually August 25, as you see on page 11, the next step is scheduled to implement the One Plan in what we call the northeast. It primarily impacts all the traffic from east-west flows from Chicago to the New York/New England area. This will complete the northern part of our CSX network.

The last slide that we have, as you see on slide 12, is what we call our I-95 corridor in our southeast. This takes in a lot of major yards such as Atlanta, Baltimore, Birmingham, Jacksonville, New Orleans, Tampa, and one of our largest yards at Wake Cross, Georgia, and southern Georgia. We will title the New Orleans gateway during this implementation to ease congestion in the southeast and facilitate a small implementation across the rest of the region. As you well know, New Orleans is a main gateway for traffic.

Phase One of the One Plan will be completed by September, and we expected to see good results. However, we do not expect to see the full value of the One Plan until the end of the first quarter of 2005. At the same time, we anticipate the continuous strong demands will be a challenge given our current operating performance. We will work to address this demand by adding important operating resources, which I have outlined to you. This will give us a better foundation to handle the expected ramp-up in volumes as we roll out our One Plan. The efforts we are focusing on will turn the operating performance around provide better service for customers and establish a more efficient and productive network.

With that, I will turn it over to Clarence Gooden, Executive Vice-President.

Thank you, and good morning, ladies and gentlemen. During the second quarter of 2004, we continued to see the economic strength that we had seen in previous quarters. The supply management index of manufacturing activity came in at 61.1 for June, the thirteenth consecutive month of expansion. You will recall that numbers above 50 signal economic expansion and numbers below 50 signal economic contraction. Leading economists have forecast industrial growth for the second quarter at 8.4%, which is higher than the previous forecast of July. And consistent with the economic news, all markets except our automotive market have experienced year-over-year revenue results.

Now let's look at the results on slide 14. During the second quarter, revenues exceeded the prior year by $108 million. This represented a 5.7% increase compared to second quarter of 2003. Second quarter 2004 was the ninth consecutive quarter of year-over-year revenue improvement, and as Michael Ward mentioned, it represents a quarterly revenue record of nearly $2 billion. Our revenue growth was driven by strong demand and continued emphasis on our yield. And as for our yield in volume on slide 16, -- 15, I'm, sorry, along with the record revenue growth, revenue for car grew 2.4%, driven by continuous focus on yield and our surcharge program. This program is crucial as we attempted to offset the high oil prices. Most markets have experienced success in improving yield. Despite the service challenges, the environment continues to be favorable towards increasing price as high demand and upward inflationary pressures exist across all transportation modes. Overall our volume was up 3.2%, again, as most markets experienced increased demand.

Now let's review the strong quarter we had in coal. On slide 16 you can see that our coal revenue of $442 million exceeded the prior year by $26 million or 6.3%. Pricing contributed to gains as the revenue per car was favorable by 4% with all of our lines of businesses in coal favorable year-over-year. In fact, our volume exceeded the prior year by 9,000 car loads or 2.2%. We attribute this to the favorable weather conditions we had, both the normal weather and into 2003 weather, as well as the electrical generation east of the Mississippi river being up 7.4% on a year-over-year basis and 6% favorable to the average of the 2000 through 2002 range. In addition, our utility inventories have been depleted in the second quarter. We estimate that those reductions in the north are now running at about 20% below normal in utility stockpiles at about 25% below normal in the south.

As we turn to our automotive business, on slide 17, automotive revenues of $220 million declined $4 million or 1.6% versus the second quarter 2003. North American light vehicle production was financially flat and favorable by 7100 vehicles. The big inventory levels as of June 30 were a 85 day supply, up 15 days year-over-year. As you are aware, manufacturer incentives are in place to stimulate sales, yet these incentives are driving weaknesses in remarketed vehicles. While we had some modest conversion successes impacting second quarter, results in automotive have been offset by losses we have in reduced service and reduced production in our other transportation plants.

As for intermodal revenue and slide 18. Our intermodal revenue grew $9 million or 2.9% on a volume of 4.2%. The mix change was the result of two accounts that we lost in what we common refer to as our third party international business in the west where we purchase and resell the underlying transportation service. Our intermodal segment grew by 22,000 units or 7%. It was in our domestic markets where we are not pleased. Essentially we grew 2,000 units or 1% -- basically flat. I'm confident that as our service levels return, we can significantly grow our business with our truck load and IMC partners by converting traffic that's currently moving on the highway.

Now turning to slide 19. Our merchandise revenue of almost $991 million increased $64 million or 6.9% versus the second quarter of 2003. Second quarter 2004 was the ninth consecutive quarter of revenue growth in merchandise. The volume improved to 755,000 car loads, which was up 4.1%, especially driven by strength in the metals, chemicals, PHOSPHATE, and the emerging markets, which I will speak to in just a moment. Finally, merchandise yielded improved by 2.7% driven on a strong focus of both our price and fuel surcharge.

Let's look at specific markets on slide 20. Rather than go through all of the markets, let's go through a few selected markets. Our metals revenue improved 15.7% on 9.2% volume growth. We continue a strong emphasis on yield across all segments of our metals market as demand for steel continues. Our emerging markets revenue improved 9.3% on 7.2% volume to growth. That growth has been strong across all of our segments except our industrial waste and machinery lines of businesses. In fact, our military traffic has shown consistency and is near 2003 levels. In our aggregate business, our rocks, if you will, growth has been limited by resource availability both in terms of track capacity and in terms of crews and locomotives and this line of business. Our chemicals revenue improved by 8.6% on 5.3% volume growth, which strong demand across most of our segments in business led by our plastics business with 15 % volume growth. Yield improvements continue with an emphasis on price and favorable mix changes. And finally in our PHOSPHATE, our fertilizer business, revenue was up 3.5% on a 7.1% volume growth. Most of the volume was increased production and exports, relatively short haul business in our Bone Valley business unit.

Finally on slide 21, looking forward is a favorable review reflected in the majority of our markets. And again, without going into each of these markets, we expect that our automotive market on a year-over-year basis will remain slightly unfavorable as inventories are remaining stubbornly high. We still have the aggressive pricing incentives in place. We will expect to be flat in free markets although we show PHOSPHATE and fertilizer as flat, please be aware that this is the fourth year that our demand in Foss if the and fertilizers have been at what is historically high numbers. Our ag products in our consumer markets we expect to be flat on a year-over-year basis, and our markets going forward that we expect to be favorable are coal markets, continued strength as we expect in all lines of our coal business especially in our utility business and in our expert business and our emerging market units we expect strong growth again in all of our markets except for machinery and industrial waste. Our metals market for the things that Michael has outlined earlier as it relates to China production and as well as the U.S. consumption, we expect to be high. And in our products, chemical and intermodal look positive as we move into the third quarter.

And now I will go to Oscar Munoz our Chief Financial Officer.

As you heard, we continue to see and expect strength in our top line, and challenges and opportunities remain in our operations. This quarter's financial results are reflect those two fundamental themes in our business. On a reported consolidated EPS business, CSX was 55 cents for the quarter compared with 59 cents last year. This quarter's results include a $15 million charge related to the management restructuring program, and I will talk about that a little later. Excluding this charge, second quarter EPS would have been 60 cents per share.

On my first slide, let me focus on the year-over-year variances for the second quarter which can be found on the right hand side of the chart. Consolidated top line revenue growth $91 million was driven by the surface transportation business and offset by revenue business in our world terminals unit. As I mentioned, in the first quarter we are now consolidated short line railroad subsidiary called four rivers transportation due to a change in GAAP requirement. This increased our surface transportation revenue by 16, and our operating income by $8 million for the second quarter. Moving down the line to expense, consolidated expense was $85 million higher driven again by mostly surface transportation. I will review the results in more detail in a few slides. I will continue to go down this chart.

Other income, which is a combination of things, is up as our resort properties and real estate decreased by $17 million. This is mainly the result of comparatively higher real estate sales in '03 offset by the discontinuance of our accounts receivable sales program that I mentioned last quarter. Additionally the same AR issue impacted the line expense increasing by 4 million from last year. CSX has consolidated net earnings including the restructuring charge were $119 million for the quarter. Move to the next chart.

We show a non-GAAP reconciliation of the impact of this restructuring charge on our results. The table on the top of the slide is a reconciliation of the impact on the charge on operating income while the table on the bottom is the same reconciliation on EPS. The current period charge was $15 million as said earlier. Without the restructuring charge, CSX's consolidated operating income would have been 306 in the second quarter, up $21 million from last year. If you look at the table on the bottom of the slide you can see the impact on the charge of EPS which was 5 cents per share. Without charge EPS would have been 60 cent compared to 59 cents last year.

Now the core business or surface transportation financials. Slide 25 shows management's view of our results, which exclude the impact of this $15 million charge. On this basis, surface transportation would have been $295 million in operating income with growth of $36 million or 14% from prior year.

Now, Clarence discussed revenue grew by 108 million or 6%. We saw record revenue in nearly all segments of the business driven by strong volume growth and our continued focus on yield improvements. Expense also grew by 4% or $72 million largely due to inflation, our inefficiency in operation, and, of course, the volume and car load growth. I will address the specific changes in the first two expense categories on the charts -- labor and fringe on separate charge later. But first let me touch on the other expense areas here on the slide. Conroe fees were $5 million lower year-over-year, and prior year safety and injury related costs that we were cycling through. Building and equipment rents, which are priced at higher cost, increased $13 million last year. The increase is driven by unfavorable mix, higher volume and lower asset utilization. Inland transportation was $7 million favorable, largely due to reduced volumes on our intermodal western network. Depreciation expense was flat. Fuel costs were up $15 million from last year due to a combination of several factors. We saw $16 million in higher fuel costs due to a roughly 10 plus cent increase in net average fuel prices. That's net of our hedging impact. I will talk about our hedge program in a few charts as well. Net average fuel price increase $5 million and volume growth was 2. And partially offsetting the items was a $8 million favorable impact for recoveries associated with foreign line fuel settlements. The net result -- excuse me. The net result for the quarter was surface transportation operating ratio of 85.2, a 1.1 basis point improvement from last year.

Now let me talk to you about the details of those big expense items. Labor and fringe and S&l. The detail show $10 million increase in labor. The primary driver of the increase was inflationary labor costs and primary expenses related to our challenges operations, specifically increase overtime and relief crews. The impact was $28 million in unfavorable expense compared to last year. Pension and incentive line increased $9 million. As I mentioned last quarter, you can expect to see larger incentive comparisons relative to last year, provided we continue to achieve our planned improvement in the bottom line. However, it is important to remember that for the upcoming quarter, the variance for the line item will be significant since we reversed for the first three quarters with the accrued management bonus in the third quarter of last year due to the performance then. The balance of the increases in labor and fringe were volume related as well as higher expense due to the four rivers entity. Partially offsetting the higher costs in labor fringe were favorable cost reductions Michael mentioned about our restructuring program. $22 million and $13 million lower cost to reductions in our contract work force. It is important to note that our head count has remained relatively flat this quarter, and we continue to hire and train T&E employees at a rate exceeding our attrition.

Turning to the next expense chart on MS&O, it increased $35 million from last year. The primary drivers of the change were $17 million in higher expense for maintenance and crew travel costs reflecting again our operations. As well as year-over-year inflationary impacts. $9 million is due to cycling prior year property and sales tax items which benefited last year and we have the same issue last quarter. We have slightly higher volume related costs in the line item and higher expense due to consolidated four rivers entity. Additionally we saw year-over-year increase cost in general operating expenses which is a combination of host of items but 50/50 related to the prior year items and both flash and any questions you have on that with David Baggs you can handle the issues there. But that was MS&O.

Moving to slide 28. I want to give you an update on our fuel hedging program. In the second quarter we were about 13% hedged at all end price including taxes and delivery of 87 cents per gallon, approximately 20 cents lower and resulted in a $4 million fuel hedging benefit. All hedge contracts with remaining quarters of 2004 have been executed, so, in essence, we are done for 2004. We are hedged at 25% for the third quarter and average price of 87 cents for the fourth. We are hedged at 40% with slightly higher price of 91 cents. And full year average hedge will be approximately 20% with roughly 89 cents a gallon being the average price. Given our current financial position relative to our peers and the way we feel and the fact that our program hedging program looks further into the future than most, we will continue to stay the course on our fuel hedging program.

Now let me conclude on the last chart. As you heard, Michael and the rest of us say, we are not as happy with the operating performance we have experienced. But consistent with our first quarter results we were able to improve the bottom line. As we look forward and, we will continue to benefit from the strong economy during the balance of the year. As Tony outlined, the One Plan is getting off to a good start and operations are showing recent signs of improvement during this period of lighter volume. Now, I must remind us that the financial improvement has historically trailed operating improvement. Excess resources are slower to come out of the system as operations improve. Additionally in this back half of the year we will bring on more resources in the form of locomotives -- locomotives and -- remains high. Furthermore we will continue to remain a balance between prudent financial management and incremental investments as we assess our needs and requirement and meeting the ongoing demand of our services and the inherent leverage that is individualably together. We were on tract to generate the 250 to $300 million in free cash and improve quality of our core earnings.

I will like to turn it back to Michael for closing remarks.

Thank you. Well, our improvement in service transportation operating income is certainly step in the right direction. We still have a long way to go, although I'm cautiously optimistic at this point. The results are reported for the industry for this quarter really demonstrate for me that leverage in this business has can be tremendous. And we believe the actions were undertaking will better capitalize on the leverage of our system. The leaders you heard from today and the terrific employees at CSX will keep us on the path of consistent and that we have demonstrated. Turnaround will take some time but we are on the right path. And frankly, have I been encouraged by the central and growing role that railroads are playing in today's transportation marketplace and I'm committing to making CSX a winner in this arena.

So with that, we would like to entertain your questions. For the benefit of the other participants on this call, I would ask that you identify yourself and your affiliation prior to asking your question. So if we can have our first question, please.

Thank you. Ladies and gentlemen, if you like to register a question, please press the one followed by the four on your telephone. You will hear a three tone prompt acknowledging your request. If your question has been answered and you would like to withdraw, press the one followed by the three. If you are using a speaker phone, please lift your hand set before entering a request. One moment please for the first question. Our first question is from the line of James Valentine with Morgan Stanley. Please proceed with your question.

Good morning, guys. I wanted to ask Tony a question regarding the One Plan in terms of the timing to get these lowered costs. Tony, you mentioned that you think you had the full savings or benefits by the first quarter of next year. I guess given that when Canadian national and Norfolk Southern undergone huge operational changes it's taken two to three years for them to get where they wanted to be. I'm trying to understand, do you talk about the full savings coming intermediate point or you are already far enough along that you can get these really big improvements in the next nine months? Trying to understand, try to reconcile this from with a we have seen in the past.

It's Oscar. Let me quickly paraphrase that or correct the statement. What Tony said was in the first quarter of '05, we will be initiating the Phase Two plan. Not that we would be completed and generating the rules. Having said that, and having Tony can talk about the length of time and how this works.

Jim, the -- as we will have the Phase One rolled out here in the middle of September. That is our goal to get all of our Phase One, which actually gets the efficiency of moving trains from across our system. But as you well know, our mixed change and we will be tweaking the plan and we will be in the first quarter of 2005 when we role out the second phase, which is a local delivery. We will continue tweaking the plan as we go along as the improvements -- as we enjoy the improvements as they roll out. It will take a tweaking time of early part of 2005 to get to that point to where we see the main benefit and then as we tweak and roll out the plan, we will get greater benefits. It is a new plan. It takes awhile and as we roll out, we will find different things that we need to do different.

But it sounds like it's somewhat of a step function where you think you will see a big piece of the savings by early to mid next year as opposed to needing to wait two or three years for this to fully roll out.

Well, I don't know if we have to wait two or three years. As this system changes and we roll out, the One Plan, then I think you will see quite a bit of improvements after the first of the year as we go into 2005. I think as we run the plan longer, we run the plan better, we will get with it and then we can start getting some efficiencies out of more efficiency with the plan as we roll it out on the long-term.

Thanks.

Some of this is in the first quarter you will see continued benefits that reach this full vibrancy over the course of 2005.

Okay, that's helpful. If I can switch gears to Oscar. Oscar, one area where you guys did real well on the cost in CSX's inland transportation cost on a year-over-year basis and sequentially the number looked phenomenal in the sense that here for the second quarter you had 40,000 more units and inland transportation cost as you went down in a sequential basis and given that's on outsource cost and those costs have gone up in the industry anywhere from 3 to 10%, I'm trying to understand what allowed that number to go down sequentially in year-over-year?

Jim, this is Clarence Gooden. Most of those costs are not -- they are underlying rail transportation costs paid to the western carriers. And with some of the issues we had in the west, we just haven't had the volumes out on the west that we had seen. In addition to that, we did our network simplification plan in the east. It was a fairly significant conversion of trailers to container. And that took away a lot of the resources that had been available to go to the west. And simultaneously we had anticipated getting 1,000 new 53 boxes, 53-foot boxes in the first quarter and because of construction delays in China due to steel issues and all, we won't be getting those boxes until October of this year. So that impacted that growth in the second quarter.

So you think that $173 million is a sustainable number going forward as a percentage of revenue?

Ask me that again.

Is that number sustainable, this new run rate here in the quarter of $173 million as a percentage of revenue for inland transportation?

It's a mix issue.

So if that mix comes back, the answer is no. If the volume comes back, no, but what will happen is profitability of intermodal will improve.

Okay. Great, thank you. Appreciate it.

Thanks.

Thank you. Our next question is from the line of Tom Wadewitz, Bear Stearns.

I have a couple questions for you here. Starting off in terms of the improvement that you will see in your network velocity and dwell, do you think that that's what's going to really drive that? Is that the rollout of the One Plan to a great extent? Or is part of that dependent on timing of additional resources? It looks like you got nice slug of Locke motives coming in -- locomotives in August but what about added crews? Are they coming on and where do you expect the bigger part of the improvement to come from?

Well, I think in this instance, we have three arenas that will improve that. One is our redesign of our plan. It's going to get completely rolled out. The middle of September. But then as it gains improvements and that will be one that will deliver some efficiencies. The locomotives will be here in time and they will be here and we have a tremendous amount of people coming on in the September, October, November time frame. It will be a combination of all three as we roll out our new system. Plus the fact that we got to get used to running the plan as the new plan is. I mean, it is a change of what we are doing today and running traffic a little bit different. So we are pretty excited about it. It's a whole new three dimensional process here.

The crew side, feel comfortable with the hiring pipeline that we have in place?

I feel comfortable that we will have enough crews to run the fall peak. It's all in how big the demand is.

One other question along those lines. As you look at the system, do you see areas where you think you need to add more capacity? I know you create capacity as you improve the velocity and the dwell times. Are there certain rail yards that need to be expanded? Are there track capacity constraints that you see there need to be some expansion and investment in order to handle volume growth? Or alternatively maybe a question from for Michael, do you consider shedding significant amounts of volume that might be lower margin in order to really drive a sharper increase in fluidity?

It says -- this is Michael. You are defining capacity as a complicated ir[u] -- issue. And when you see a big spike in traffic as we have done here, the spikes obviously make things difficult to handle because of the lead time when some of the assets like locomotives, cars and crew hiring side. And having services challenges add to that. I think the long term I'm not overly concerned about capacity constraints. One, as we roll out this One Plan as you noted, that will free up capacity for us because as you use the assets more efficiently and it lets you deploy the cars and locomotives for additional businesses. And I think the one real benefit of this One Plan is with this redesign as we evolve, it gives us better clarity as we need cars, locomotives, or sidings. When we reach that point, we will know a lot better where to add those. We think, though, with the strong growth that we expect to see, a sustained period here, we will be in a position with the strong profitable growth to make those capital developments -- investments when the time becomes appropriate. So overall, there is a few spots you will find here and there, but I don't see big, big issues. On your issue of which business -- maybe I could ask Clarence to address that. He has been doing some things there in that arena.

Well, Tom, we haven't made moves per se to just reduced cars online for example. What we have done is classic yield management where you have more demand than you have capacity you can read that as cars or whatever the particular case would be in certain markets. And then those markets we try to go with what either were strategic counts for us long term or accounts that had high yield, high contribution levels. And in the case of the intermodal network service initiative where we had worked implementation initiative, we tried to eliminate the business we were handling because of the complexity of the business and how it was -- what it was doing to the network. And in a specific instance of the intermodal redesign, we were able to increase the fluidity and velocity through Jacksonville which was impacting not only our intermodal network but ow ought motive network and our coal network significantly once we were able to put that in. I would describe it more as either simplicity of operations or as yield management.

Just one follow-up for you, Clarence. Do you expect to ask for more on the pricing side as you see some of the service improvement get realized? Is their ability to get tight ground capacity 3% today to 6% a couple months from now for contract repriced in our overall philosophy? Is that the price where market demand is?

The greater the demand, the greater the price that we are able to get. And with capacity in all transportation modes as you are aware of being extremely tight, capacity when it is very tight is the friend of price when it is excess capacity as the enemy of price. I having said that, as we improve in our intermodal network, we will be able to go after some of the higher yielding truck load moves that we have not been able to be joy in the first half of this year by taking that business off the highway. I would ask you about saying there is a combination of events there.

Right. Thank you for the time.

Our next question is from the line of Brad Davis, Merrill Lynch. Please proceed.

It's actually Brad on behalf of Ken. Just a question with the rollout of your One Plan and the new locomotives.

At this point in time we are not -- this is Oscar, we aren't locked down on that number. We had a number before. Clearly was the economic rebound and the value of the business. I'm sorry for '04, we been out there with $1 billion. And we are still on that number at this point in time. I thought it was a forward looking question.

And the tax hike, we got it at 35 per quarter. Do we expect that to continue or a bit higher? Tax rate.

I'm sorry, again?

35% tax rate for the quarter. Would you expect that to continue or --

Closer to 37.

Thank you.

Our next question is from the line of Scott Flower, Smith Barney Citigroup.

Good morning. Had several questions for different areas of the business. I'm wondering and maybe this is a question for Tony or Michael. On the One Plan, you are moving forward in a methodical progression. I'm wondering particularly given the consequence of the southeastern part of your network, how comfortable you feel about embarking on that in early September and having that in good shape before you absolutely hit the peak in volumes? Do you have a contingency plans to push that off if some of the other stages take a little longer to get set as you want it? I'm trying to understand how you gauge the risk or lack of risk in making that change in that part of the system in September right before peak.

Well, this is Tony. We looked at our traffic areas and that's why we picked the Mid West to start with to go. That was the area that was primarily focused on delivery of setup automobiles. We went to that area first because business was down and it was primarily automobiles so we went there. There is not much change in the northeast. And we figured that the traffic levels between South Carolina, North Carolina, Georgia and Florida will remain pretty cost there in September and that will be a time that we can get it rolled out. We were real comfortable here early on that our data went from a test in environment to actual data for the setup of our trains without flaw. And we are real excited about the volumes that got transferred. So we feel good about the implementation of moving trains around. The biggest issues that you run into sometimes of that is when you reclassify cars at certain yards like we did in Cincinnati and Louisville where we had several blocks of cars that had to move out of Louisville into Cincinnati and vice versa and that cleaned up real good at the low volumes. So we are pretty excited about the numbers that we are seeing cleaning up and the volume that we expect to be in September indicate that we can handle that during the rollout of that area.

Just one other comment I would add, isn't it correct that a lot of the changes aren't in so much the number of trains we were running, but what's on those trains. Simplifying the work within the terminals so the total number of trains, ie, how many locomotion and crews you won't change. Won't change dramatically, it's simplifying some of the work in the terminals which will help us in the peak.

And just a couple other quick questions. And again this may be a question either for Oscar or Tony, could you elaborate more on the contract work for us reductions, I guess? I was vaguely or not aware of the amount of savings could get to that run rate? And is that a run rate of the 13 to 15 million range? Elaborate perhaps a little more on what those are and what we should be contemplating for a sort of run rate of savings.

There is specifically not T and E employees. Mechanical engineering and clerical. A big portion of the clerical ones. I would forecast out -- what I have given you numbers which you want, the contract labor force in the clerk arena is a definite roll forward. We will maintain those savings. I think on the mechanical and engineering side with Tony arriving, one of the things we talked about on one of his first days is we have a very solid operating guy who knows his business and as he determines needs, we will ensure that we will meet those needs. As we look forward to the back half of the year, we will look at that. I would say that at least half of that will continue through the remainder part of the year.

While have I you, Oscar, I know that you don't want to get locked down in terms of the prior question on Cap Ex, but maybe if I changed the wording and look at that time this way, unless business volumes were to materially moderate, is it fair to say that the starting point in terms of Cap Ex for next year is a billion and you will assess your needs in what level it might go above that but you will spend as 3467 as this year?

Let me avoid that one for now. I mean, we have several bits of work to be done across a whole different area. But we will be back to be on that shortly. We are looking at that as we speak.

It sounds like it's uncertain if it might be less or might be more?

There is only two ways to go, right?

Just cleanup question, could either Oscar or Clarence give me a sense of how much fuel surcharge revenue did you all year-over-year pick up in the quarter?

I think we have a rich history of not answering that question as well. So sorry.

Our next question is from the Jordan from Deutsche Banc.

Just a couple things. One, I think you mentioned head count ads of about 1400. Do you have a sense of what it may be on a net basis in the next couple of quarters?

Are you talking about as far as the new T and a? That was our hiring for this year for the 1400 was our mark and it's moved up a little bit as our hiring and attrition has changed. You are talking about total head count? Or hiring head count?

That's 1400. I was wondering if that was just total hirings? After attritions?

The 1400 is our total hiring and that has changing every day. Explained earlier. That's only T and E personnel that operates the trains. And that's roughly 25% above the expected attrition rate. And that may increase toward the end of the year as we look at our 2005 number. That's our hiring and that's about 20 to 25% above our attrition.

Okay, thanks. And then I think you mentioned the average cost on the fuel hedge for the balance of this year. Do you have sort of what the cost per gallon roughly looks like for '05 at this point?

We do, but I'm not ready to talk about that.

Okay. And then just the final question, as you roll out the One Plan, care to venture a target as to what you would look for six months down the line? Nine months down the line? However you want to look at in terms of targets for velocity or dwell time.

Tony?

Well, today we are run being a 21-mile-per-hour on the velocity and at about a 27, 28 as we come through the holiday season and clean up. We should -- if we roll that out -- you know, when you get an increase in a lot of car loads and volumes, it will slow down, if we can keep it to that level above, we would be quite pleased with that under a heavy demand load.

We were using 6 to post OEI, wouldn't your view be higher than that or not?

Yeah, some of our history numbers goes back as 22.5. That's what we did back when the system -- system was running pretty flied with. So we are looking at those numbers.

Thank you very much.

Depends on the volume.

Thank you.

Our next question is from the line of Greg Burns, J.P. Morgan.

Hi, guys. Couple quick questions. Did I hear right that the incentive accruals were reversed all in the third quarter of last year and do you remember what that number was?

Yes. It was roughly -- yes to the first question. We did reverse all of the -- in Q3 and it was around $30 million.

And second question is, on the peak season given the outlook seems to be strong volumes across the board. We have seen rationalization at terminals out west. Are you doing anything there or stuff now to rationalize and turn away business? Or do you anticipate doing anything there?

No. Go ahead.

As far as the rationalization of the yards, we aren't looking to reduce any of our facilities at this point or any track. Our One Plan is that rolls out takes into consideration that you use your existing capacity. So we aren't looking at taking any of those out.

I'm sorry. I meant rationing. Are you doing anything to ration ship or freight?

Well, I not sure how to answer that. Let me tell you why I say that. My inclination is to tell you no, we are not. [OOPS] There is nothing specific. The flip side of that is that in certain lines of our business our metals market would be an example of that, our box car market would be an example of that, there is not a lot of capacity left in there because of all the fleets are being fully utilized, center beam cars for lumber. Pipe flats would be another example. It's not a case of rationalizing, it's a case of finite number that we can handle. The good news is that as Tony improves this velocity which he has consistently been improving since June 10 and capacity additional capacity is in fact created. Our order fulfillment rate in the last couple of weeks for certain of those commodities that I just mentioned is up. It is not up to the levels where it meets 100% of the demand. But it's up considerably from where it was two or three months ago on meeting the demand.

We have no official programs to rationalize any -- That is correct. No official programs.

Thank you.

Thank you. Your next question is from the line of Jennifer Ritter, Lehman Brothers.

Good morning. I wanted to comment a little or ask your opinion on the fall peak. We heard from Norfolk Southern the idea that maybe this peak season will be a little more spread out or consistent and start a little earlier than past seasons. I wondered if you guys could give your opinion on that and also if you could give us an update on how the Con rail spin is going.

On our projections for the fall peak, I was asked this question yesterday, as a matter of fact, by someone. We have peaks throughout the year and vary from commodity group to commodity groups when you have those peaks. Our fall peak for our international traffic will start ramping up in mid August. And we will run right on up to about Thanksgiving for the Christmas season, Jennifer. And what we expect to see is that import container gross into the country will be slightly higher than they have been in previous peaks. There is a lot of vessel capacity coming on in the trans pacific trade in the Pacific that we will have benefit of those volumes from. Our [ag] market, our corn and feed markets solely dependent on the weather. If the weather comes in early, that crop could come in obviously early. Early being in October if it runs what its traditional peaks have been, it will be somewhere in mid October. For our railroad in the east and it would be different than some of the western carriers, we won't see I don't believe as big a export grain market as we have seen in the past. And thirdly, we expect to see a fairly strong revenue season, a very strong car loading season from right now, right on through to the end of the year. So the basic fundamental commodities that we are hauling, metal to scrap metal and industrial waste and municipal solid waste and all, we expect it to be very strong. I guess in summary I would say that you will see one of the more sustained periods of car load and revenue growth that we have seen in North American railroading if quite a few years.

Jennifer on your Con rail spin question, we launched our exchange offer for all the unsecured debt earlier this week. If you are interested in the terms they are in the offering documents. We will expect jointly with -- we will expect to complete the -- in -- spin-off in the back half of the year.

Great, thanks.

Thank you. Our next question is from the line of John Largen with Legg Mason.

Good morning. I had a question on pricing again, not to beat a dead horse over the head. But your pricing on a revenue per car basis look good, especially with intermodal car being down. And some of that is the management that Clarence talked about. Some of it may be the cost system that Oscar has been talking about. Can you give us a sense for on the contracts that have come up for renewal the past 12 months with a little specificity by business line, what kind of revenue per car increases you getting kind of in each business.

Well, John, this is Clarence. Good to talk to you, by the way. Let me say this to you. In December, when we report actually in January when I came here for the first time to report, I reported on our fourth quarter numbers as I was making the transition. And at that time, you I guess were coming back into the business and I said that our yields were not favorable. They were not as good pricing efforts as we should have been making all along and I promised you at that time we would improve those. And when we reported our first quarter numbers they had improved. And when we reported our second quarter numbers they had improved more. And when we report our third quarter numbers they will improve more. And they are a result not only at the system that Oscar has brought and that we have been talking about, they are not only the result of the increased transportation demand, they are not only the result of a lot of hard work by ourselves and marketing people, but they are in combinations of all of those. And it varies from market to market. I mean, there are some markets that we get some increases in that are nothing to write home to mom about. They have a lot of competitive factors that are in them. There are other markets where there is just huge, huge demand for those particular types of cars. And for those particular times of services that we have been able to get. But I think it's a very attractive and significant rate increases. What I don't want to do is talk about a specific customer or a specific account. Or specific percent for all of the competitive reasons and that you can imagine in the marketplace. But they have been very, very promising results.

Clarence, can you tell us what percentage of your business is covered under contract and what percentage of those contracts have come up for price renegotiations in 2004?

I can't do that off the top of my head. I could do that by telling you that in the third quarter we will not have some of the pricing opportunities in our coal markets and our automotive markets that we have had in other quarters that changes again in the fourth quarter. And our merchandise markets and in our intermodal markets combined we have some we are in the neighborhood of 600 to 8 100 million worth of contracts that will be up for renewal in that time period.

Okay. And one longer term question regarding the One Plan, sounds like Phase One is pretty well going to be rolled out by the end of the year and start into Phase Two next year. I seem to remember you talking about maybe two to 300 and maybe as much as 400 basis points of overall potential in margin expansion opportunities. What percentage of that total opportunity do you think is tied to Phase One and what percentage I tied to Phase Two? Just so we can get a handle on how this will roll out over the next couple of years.

The 2 to 300 basis points that we talked about was generally what the consultants and in our conversations with other -- that implemented similar programs is getting a general range and was that sort of talking about number. As it begins to get implemented and we bring the results, I think we will quantify that information and talk about it as we again talk about our future numbers. At this point in time, it would be very premature to assign a specific number to this Phase One.

Fair enough. Thank you very much.

And our last question of the conference is from the line of Ken Hoexter with Merrill Lynch.

Tony, are you planning on selling any network or disposing any assets as you go through the network and clean up different aspects of the system?

Yes, it's Oscar. We have a network rationalization plan in place that has been if place prior to this. And we have specific analysis and focus around this. So as opposed to a related function of the One Plan, we have a broader program in place of about 800 to 1,000 miles of network this year. That doesn't come into play with the One Plan. As the One Plan develops, and we get a more and a broader strategic view where the freight wants to move, there may be some changes that we make to that that may be related. At this point in time it's a concurrent program but relatively unlinked from that perspective.

And then Oscar, another follow-up on the fuel surcharge, I missed what you were saying before. Norfolk again this morning kind of announced they were terminating or suspending their program with these record levels. I know you were relatively new at starting the program since, February if I remember right. Is this -- does that affect you at all? Do you keep going at this even with prices at I saw $43 this morning?

As I mentioned in our remarks, the reason we went into this was to reduce the volatility. Given our financial situation going to be our other peers in the railroad and our need for a consistent continuous sort of move with our operation, it does make sense for us to continue. We clearly monitor and review those forward markets. Our things are over a longer term nature. So our internal valuations are still a positive thing for us. We will continue with it.

Great to hear Oscar. One last question if I can for Clarence. Just from the coal perspective, you know, it seems like the coal companies were coming out and saying that the rail companies were the reason why we -- they weren't able to meet their own targets. I just love to hear your rebuttal from that. Also, is it because we are seeing a shift? Could you see more of the success of the export volumes pulling the capacity away from the utilities? Or is there something more to it? Thank you.

Thank you. I'm only aware of only one coal company that came out with that. And certainly we regretted that. As it relates to the export coal market, although our export coal market is in fact almost 100% year-over-year, it went from essentially being 5% of our car load to 9% of our car loads and it's handled and as you know in our network between our coal fields in West Virginia principally to Newport news which is a efficient operation for us and allows us to turn those cars, those assets, those crews very efficiently and effectively. In addition to that, Tony has put on a special management task force to look at our coal flows particularly through to the south and southeast and to the Carolinas. It's starting to really show a lot of fruits. Our loadings are up almost 2,000 cars a week over what they had been there in that gateway. We have several utilities that we are working with to ensure that their coal supplies are adequate. We feel like that we had very positive results there. So you know, my own view of it is that we made fairly significant improvement in our ability to move the coal and the last two or three months.

Great, thanks a lot. I look forward to hearing more on the One Plan progress.

Thank you very much. Appreciate you joining us today.

Ladies and gentlemen, that does conclude the conference call today. We thank you for your participation and ask that you please disconnect your lines.