CSX Corp (CSX) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation third quarter 2006 earnings call.

As a reminder, today's call is being recorded. During this call, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. [OPERATOR INSTRUCTIONS]

For opening remarks and introduction, I would like to turn the call over to Mr. David Baggs, Assistant Vice President Investor Relations for CSX Corporation. Sir, you may begin.

Thank you, Lisa, and good morning, everyone, and welcome to CSX Corporation's third quarter 2006 earnings presentation.

The presentation material that we'll review this morning, along with our CSX flash and our quarterly safety and service measurements, are available on our Web site at csx.com under "Investors". In addition, following the presentation, a Webcast and podcast replay will be available.

Here representing CSX this morning are Michael Ward, the Company's Chief Executive Officer, Tony Ingram, Chief Operating Officer, Clarence Gooden, Chief Sales and Marketing Officer, and Oscar Munoz, Chief Financial Officer.

Before we begin the formal part of our program, let me remind everyone that the presentation and other statements made by the Company contain forward-looking statements and actual performance could differ materially from the results anticipated by these statements.

And with that, let me turn the presentation over to CSX Corporation's Chairman, President, and Chief Executive Officer, Michael Ward. Michael?

Thank you, David. Good morning, everyone.

CSX earnings for the third quarter continue to reflect our record-setting pace in our service transportation businesses. Reported earnings of $0.71 per share include insurance recoveries and income tax adjustments in the quarter. Excluding these items, earnings were $0.54 per share, up 50% from the same period last year.

Our service transportation businesses generated record third quarter revenues of $2.4 billion and record third quarter operating income of $474 million adjusting for the insurance recoveries. This represents a 31% increase over the third quarter of 2005.

As Clarence will discuss further, we continued to see pricing momentum across all business segments, with about 5% growth in pure price excluding mix and fuel surcharge, and we expect similar price increases in 2007. In addition, we achieved volume growth in several key business segments, highlighted by more than 7% in coal and nearly 4% in intermodal.

As Tony will discuss, the ONE Plan continued to produce strong results and the team is now focused on raising the bar every day. As we look forward, transportation demand remains strong and the overall economy remains healthy with expected growth in the 2 to 3% range for both 2007 and 2008. In short, we're pleased with our third quarter results and remain on the track to deliver consistent, continuous improvement.

At this point, Clarence will provide the details of our business segments. Clarence?

Thank you, Michael, and good morning, everyone.

CSX achieved another successful quarter in the midst of continued strong demand for rail and intermodal traffic, which was driven by energy demand, agricultural, and growth and foreign trade across several businesses. These favorable market conditions and our improved service led to record third quarter revenues of $2.4 billion, which exceeded the prior year by $293 million.

Revenue growth during the quarter was led by our coal and merchandise markets with our intermodal unit also experiencing solid growth. Overall volume increased nearly 2% from a year ago as continued strength in coal and agriculture, plus renewed strength in intermodal more than offset declines in phosphate, automotive, and forest and paper markets.

We also achieved continued success in yield improvement. As you can see on the next slide, in the third quarter of 2006 overall revenue per unit grew nearly 12%, driven by increased pricing and our fuel surcharge program. Revenue per unit gains were strongest in the merchandise market at 17% followed by coal at 9%, automotive at 4%, and intermodal at 4%.

During the quarter, the drivers of this revenue per unit increase were approximately 40% due to price, 35% due to fuel surcharge, and 25% due to favorable mix. Declines in the short haul phosphate traffic were the primary drivers of this mix impact.

The environment continues to be favorable for pricing. Moving forward for the remainder of 2006 and into 2007 we expect to continue our momentum in improving yield.

Now discussing our merchandise markets. Quarterly merchandise revenue of over $1.2 billion increased 16% on a volume decrease of 1%. This represented the 18th consecutive quarter of year-over-year merchandise revenue growth.

Merchandise markets recorded stronger yields in all markets as revenue per unit increased 17%. The volume decrease in merchandise was primarily driven by the continued impacts from phosphate and fertilizer plant closures and a softening in the housing market, yet growth was achieved in several other segments.

Excluding the phosphate declines of 18,000 carloads, overall merchandise volumes would have been favorable by 2%. Moving forward, the outlook for revenue growth is favorable for the remainder of 2006 and the outlook for revenue and volume are both expected to be favorable in 2007.

Let's take a closer look at our volume. As you can see, merchandise volumes grew in four of the seven markets. The markets that saw the largest gains were the agricultural products and the metal segments.

In agricultural products improvements in grain unit train service continued to contribute to growth as did strong demand for ethanol shipments. In metals, service improvements led to better asset utilization which in conjunction with the strong demand led to a 3% volume growth.

Chemicals experienced renewed growth primarily driven by stronger liquid petroleum gas volumes and Katrina-related impacts during last year's third quarter. Strong demand for movement of aggregate products, municipal waste, military shipments, and machinery drove emerging markets volumes up 1% for the third quarter.

As mentioned earlier, the market which we saw the most significant declines in volumes was phosphates and fertilizers. Also shedding of low-margin traffic and the softening in the housing market has negatively impacted volumes in forest products.

Now looking at our coal, coke, and iron ore. Quarterly coal revenue of $602 million increased nearly 18% on a volume increase of 7%.

Strong demand continues in coal. Growth was strongest in the utility and river markets as inventories were replenished and as supply increased, especially in traffic from the Powder River Basin

Growth was also driven by strong steel-related demand, improved service and cycle times, as well as additional car resources in our coke and iron ore markets. Revenue per car increased 9% and we believe that the favorable environment for pricing will continue in coal.

Revenue and volume outlook remains favorable for the remainder of 2006 as electrical generation demand remains strong and alternative fuels are expected to remain expensive. Looking into 2007, overall volume will be influenced by weather, while revenue growth will remain strong due to continued pricing opportunities associated with contract renewals.

Now turning to our automotive business. Quarterly automotive revenue of $183 million decreased 9% on less volume. North American light vehicle production for the big three continues to decline, more than offsetting growth with the new domestic producers yet, CSX shipments from Honda at Marysville and Hyundai at Montgomery continue to grow.

Continued price increases and improved fuel surcharge coverage resulted in a revenue per unit increase of 4%. The outlook for revenue and volume for the remainder of the year is expected to be unfavorable.

Turning to our intermodal results. Quarterly intermodal revenue of $364 million increased 8% on a volume increase of 4%. Volume increase was driven by growth in our core intermodal traffic that more than offset reductions in our off-core traffic.

Overall, revenue per unit increased 4% largely due to increased price and fuel surcharge coverage that more than offset mix-related impacts from the loss of the off-core traffic. Third quarter 2006 also represents the tenth consecutive quarter of year-over-year operating income improvement.

We are extremely pleased with these positive results and expect them to continue as we grow the volume profitably in the remainder of 2006 and into 2007.

Turning to the next slide, the overall economic environment in our view remains positive. Of course, there's puts and takes in the economy.

While the housing and automotive sectors have softened, business investment in foreign trade will continue to drive the volume growth. Overall, the economy is expected to grow between 2 and 3% in 2007 and in 2008.

Looking forward we expect 2 to 3% volume growth for the fourth quarter. This continues the improving volume trend we've seen throughout the year with a 1% decline in the first quarter, flat volumes in the second quarter, and 2% growth here in the third quarter. Service improvements will also continue to support volume growth.

The favorable pricing environment continues due to strong demand, high fuel prices, and tight transportation supply. We will remain focused on improving the bottom line profitability.

Thank you very much and let me introduce Tony Ingram, our Chief Operating Officer.

Thank you, Clarence, and good morning everyone.

Today I'm going to give you a quick update on our three critical performance drivers. First, our safety results continue to improve. We're getting these results with outstanding leadership across the organization.

Second, the railroad is running well. We're executing better, we're turning the assets and we're running trains to schedule. Finally, our expansion capacity program remains on schedule.

Now let's look at our safety performance. On Slide 17, you see the positive trend in safety continues.

Personal injuries for the 13 weeks, or the average for the third quarter, improved to 1.37. This is a 28% improvement versus the same period of 2005.

Decreased train accidents are another great story, down 29% over the quarter and over 8% on a rolling 12 months. Our momentum in both of these areas remain strong.

[Inaudible] I'm very pleased with these results, the work here is never done. The leadership that strives to improve safety also drives improved service. This brings me to my next slide.

These results show we are running a more disciplined operation. Trains are leaving and arriving on time with greater frequency.

Originations improved to 77% in the quarter, a 50% improvement versus 2005. You can see the same trend in arrivals.

The team continues to embrace the ONE Plan and is focused on consistent execution. In the end, our customers are getting more reliable service.

On Slide 19, you can see that better execution is making our network more fluid and improving asset utilization. Both dwell time and cars online continue to improve. On average, dwell time improved to 25.5 hours in the third quarter and the trend remains favorable on a rolling 12 months.

Cars online remain at a low level, down to about 225,000 cars. As we remain focused on operating discipline, we should see continuous improvements in these measures.

On Slide 20 shows our velocity, which measures average train speed on the network. Third quarter velocity averaged 19.8 miles per hour. The rolling 12-month average remains stable at 19.5 miles per hour.

With velocity stable, the network is running better, asset utilization is improving, and our customers are seeing more reliable service, which is critical to our success.

Looking forward to Slide 21, the safety momentum will continue. Disciplined execution of the ONE Plan is making us more reliable, fluid, and efficient and we expect that to continue.

Finally, our capital investments will stay right on schedule. Once in place, this capacity will improve service reliability and support growth in key service lanes.

Overall, we delivered another quarter of steady, continuous improvement in safety, service, and asset utilization. Going forward, we will keep building on our foundation, which is leadership, discipline, and execution.

With that, I'll turn it over to Oscar Munoz, our CFO.

Thank you, Tony.

Moving to my charts and starting with EPS at the bottom of the page, and as Michael mentioned, we did report earnings per share of $0.71 for the third quarter, an increase of $0.35 over the prior year. If you move back to the top of the chart, these results were driven by surface transportation operating income which increased $128 million, including a $15 million gain on insurance recovery.

Other operating income increased $8 million as we are cycling last year's wind-down costs from our former container shipping operation. As we move below the line, other income increased $14 million, primarily reflecting higher interest income of $3 million, real estate of $3 million, and an $8 million in other non-core activities, the details of which you can find in our flash document.

Interest expense for the quarter decreased $3 million as we refinanced some of our floating rate debt at lower rates.

Finally, our income tax line includes the impact of our increased earnings and an income tax benefit of $69 million, principally related to the resolution of 1994 through 1996 federal income tax audit. Adjusting for those items we continue to have an approximate 38% effective tax rate.

Turning to the next slide, I would like to review a reconciliation of our GAAP results. On the top of the slide, you can see a reconciliation of surface transportation operating income. Removing the gain from insurance recoveries, surface trans operating income for the third quarter was $474 million, an improvement of $113 million, or 31% for the quarter.

Turning to EPS, you can see the impacts from both the insurance gain as well as the resolution of income tax matters I previously discussed. So on a comparable basis, earnings per share for the third quarter of 2006 were $0.54, a 50% increase from last year.

Now let me take you through the details of our surface transportation results on the next slide. As Clarence discussed, our top line growth was 14% reflecting continued yield strength, increased fuel surcharge coverage, favorable impact from mix, and our growing volumes.

On the cost side, total expenses increased 10%, or $180 million for the quarter. The main driver of this was fuel, which increased $112 million, or 60%.

Excluding fuel, total expenses were up 4% primarily due to inflation and higher costs associated with our 2% increase in business volumes. The net result was a 31% increase in operating income and an 80.4 operating ratio for the quarter. This was a 260 basis point improvement from prior year.

Now let's discuss our expenses on a more detailed view over the next few slides. On Slide 26, labor and fringe increased $11 million, or 2% over last year.

This was driven by wage and benefit inflation of $18 million as well as higher costs associated with an increase of over 400 train crew employees due to our continued commitment to hire and train crews ahead of attrition. These increases were partially offset by lower incentive compensation expense of $13 million.

Moving to the next slide, let me review our material supplies and other, or MS&O, expenses. Total MS&O expenses increased by $23 million, or 5%, primarily reflecting sharply higher materials inflation, rising insurance costs, as well as expenses related to our increased business activity.

These increases were partially offset by productivity gains from our improved operations. An example of this was the improvement we saw in locomotive costs due to increased locomotive asset utilization in the quarter.

Now let's talk about fuel on the next slide. You can look at the quarter's $300 million fuel costs as being simply driven by our 144 million gallons of fuel consumed at an average fuel price of $2.09 a gallon. Overall, fuel increased $112 million, or 60% versus last year primarily driven by $76 million in reduced hedge benefits due to our now expired hedge positions and by a higher fuel price of $32 million.

Now moving to the next slide, let me talk about rents. Current year rent expense has moved consistent with volumes. The $6 million increase we saw from last year is primarily due to the cycling of a prior-year item.

On a go-forward basis, you can expect building and equipment rents to continue to trend with our business activity.

On the next slide, let's talk about the remaining expenses. All other increased $28 million, or 10% in total with each of the three expense categories seeing an increase versus prior year.

First, depreciation expense was higher due to a net increase in our capital asset base, second, we saw higher inland transportation expenses due to our increased intermodal volume and related work activity such as higher trucking costs. And third, we are cycling a Conrail federal tax benefit which is driving the year-over-year increase in our Conrail fees.

Let me wrap up on the next slide. First, I'd like to provide you a status update on our share buyback program.

As you recall, we announced a $500 million share buyback program in our second quarter earnings call. I'm pleased to report that we have already completed over 50% of the program's goal by purchasing $272 million worth of shares in the last few months. That, combined with our program, we completed in the first half, brings our shares repurchased to a total or $422 million for the year.

Turning to cash, we are on track with our $1.4 billion capital program and expect to generate $300 plus million in free cash flow in 2006, including our insurance recoveries related to Hurricane Katrina and the dividend increase we announced earlier this quarter.

Clearly, we are pleased with what we have accomplished to date, and as Michael and Clarence discussed, the outlook for rail and intermodal demand remains strong. When you combine that with the steady operating performance we've seen from Tony's team, we are poised to continue our solid financial performance and profitable growth.

So with that, let me turn it back over to Michael for his remarks.

Thank you, Oscar.

Once again, we are delivering for our shareholders. With the addition of volume growth in the third quarter, we have momentum across all our strategies and the team is now hitting on all cylinders.

The renaissance in our industry continues and the demand for rail transportation and intermodal services remains strong across most of our business segments. With our advanced network and improving service levels across our system, our business will continue to grow.

So with that, we'll be happy to take your questions. As you do so, please identify yourself for the benefit of those on the call. Operator, we're ready to take calls at this point.

Thank you. [OPERATOR INSTRUCTIONS] Thank you. Our first question comes from Ken Hoexter with Merrill Lynch.

Great. Good morning. It's Ken Hoexter.

On the intermodal, just, as you focus now, you said the margin improvement is slowing a bit on a year-over-year basis, still seeing the growth there. Now that you've turned your focus back towards growing the intermodal side, you posted about 4% volume growth.

What does it take, or are you looking to get back to, I guess, the entire rail group is getting about 5.5. Should we continue to see that accelerate, or are these levels that you're more pleased with growing at?

Ken, this is Clarence Gooden.

I think we told you last August that you could expect to see our growth going forward in our intermodal business at around the 5 to 7% range. We're ramping up to that range right now. After the first of the year, I think you'll start to see growth in our intermodal product somewhere in the neighborhood of that 5 to 7% range.

Okay.

And just on that same topic, other intermodal was down quite significantly. What is -- I think you mentioned the off-core, what is that made up of? It's not domestic, it's not international. What is that contributed?

That other line on our intermodal unit is not rail freight that we're moving at all, it's ancillary charges. So what you've seen this year in the fall peak has been some of the ancillary charges haven't been as high as they were last year during the same period of time.

Is that because you're more efficient so you're not getting that income anymore?

No. It's because the trans loads mainly on the West Coast have impacted that.

So there will be more efficient less [inaudible] that is [inaudible].

That's right.

Okay.

And then previously, you said about 20% of your coal contracts are coming due in the fourth quarter. Is that -- how have negotiations gone? Can you comment on the process?

They have gone very well. We're very positive and upbeat about our coal revenues next year. We think our pricing will continue to be firm and very strong in our coal business next year.

Okay.

Last question is just on the phosphate side. Have we lapped that closing now? I guess they've been down pretty large for almost a year now. When do we lap a majority of the shutdowns?

About half of it gets lapped somewhere between the middle of December and the middle of January and the other half gets lapped somewhere around the middle of April, first of May. There were two sets of closings there that involved two different companies.

Got it. Great job. Thanks a lot.

Thank you. Our next question comes from Tom Wadewitz with JPMorgan.

Good morning.

Good morning, Tom.

Let's see, so I've got, I guess, two different things for you here.

On the fuel side, it looks like you've had a decline in fuel hedge and we estimate that probably hurt you on the order of maybe 130, 150 basis points in second quarter, third quarter. Obviously a pretty sharp decline in fuel prices over the last month.

I want to know if you can give us a sense of, as this fuel comes down is, it much less of a headwind in fourth quarter or is there still a significant headwind? And then I suppose looking to '07, is there a benefit from this decline in fuel or is it just purely offset by the surcharge position?

Hi, Tom, this is Oscar.

Probably part of your last statement is the more correct one. As you go forward, it's hard to figure out where the price of fuel is headed, but what I can say is we expect minimal impact from any fuel price shift, either up or down. As I think we've stated publicly, we strive for fuel price neutrality and that's probably our best looking forward statement at this time.

Can you give a sense in fourth quarter? Because I mean I think it's fair to say that the hedge reduction's been a bit of a headwind. Is that less of a headwind in fourth quarter and does the fuel price reduction actually help a little bit in fourth quarter?

Again, it's difficult to forecast what fuel price is going to do and so I'll stand by the last statement. The neutrality's where we're headed and we're trying to stay away from trying to forecast either sharp declines or increases.

Okay. Fair enough. And then one I think for Tony or Michael.

You've done a great job on improving the fluidity and showing some improvement in the operating metrics. As you look at some of these capacity projects coming online in fourth quarter and then you've got some in '07, is there potential that they would enable a further leg-up in terms of velocity or dwell that would help you on the cost side, or should we not necessarily consider that with the capacity projects? It seems that might be a possibility with capacity coming online.

Tom, in looking at the projects that we've been able to get in so far, we've had some improvement in the velocity on certain areas. But you've got to keep in mind this is a network, all this ties together and our route between Chicago and Jacksonville is a route where we're putting a preponderance of our improvements.

So I think there'll be a little bit of improvement in the velocity. I don't know if you'll see that much improvement in the cost, other than the fact that we'll have capacity to move the trains and be more fluid and when that happens, you'll reduce cost.

It also helps with the reliability. So when the issues occur with that extra capacity we have on there, it helps us prepare for future growth we expect as well as increase the recoverability to provide that reliable service to our customers.

Okay. Great. Good results and thanks for the time.

Thank you.

Thank you. Our next question comes from Edward Wolfe with Bear Stearns.

Hey, good morning, guys.

Good morning.

Clarence, could you just give a little bit of an update? You sound very confident in the coal business, obviously, on the pricing side. But with all the recent Central App production cuts we're hearing from different mines, why should coal volumes grow next year? Can you talk to us what's specific to CSX about that?

Our own view of it is, is that the utility stockpiles are approaching target levels. Having said that, the utilities are telling us that they plan to still continue to build at some moderate pace those stockpiles as we go into 2007. So that would be one factor.

The second factor is that we're still seeing strong production in Central Appalachia and, in fact, some of the growth that we experienced this year, about 3% of that 7% number in growth that you saw, Ed, was from western coal.

The third factor, as you know, is that coal is highly weather-dependent. So if we get any kind of adverse weather, very cold, very hot next year, we think that we'll have benefits from that.

And then on the pricing side, we have coal contracts that are up for renewal next year, and we feel very positive about our ability to get rate in those contracts, particularly given the fact they have not been renewed since the 2004 time period.

I don't question the demand side, I don't think investors are concerned with that, it's really the production side. Are any of the mines that you serve telling you that they're cutting production, you know, because of their own cost issues production and do you have any new utilities coming online? If I recall, there's something in the fourth quarter, is there next year as well?

No, we have one that's coming on in the fourth quarter in South Carolina and our production on an annualized basis on CSX is up about 12 million tons this year.

Is there an estimate of just your mines what they're supposed to be up next year? Have they given you that kind of estimates at this point?

I do not have that number.

A couple of small things.

Oscar, you had mentioned a one-time negative in the rents during the quarter. I didn't quite understand what that was. The impact to rents when you were going over the expenses.

It's a prior-year item. We had a benefit in one of our divisions, just some procedural issues where we took sort of a one-time good [guy] and so we're just cycling that and it's the majority of that year-over-year variance.

And the other income, how much of that is from your energy business, and how ongoing should we think of that?

It's the majority of that variance. I think it was 8 or $9 million that portion was, that's the majority. And as we wind down that activity, we had costs associated with that business. So really we'll cycle some of that over the next three quarters probably in that same general vicinity, but it's hard to look forward.

That other income line, if you look at it, the biggest driver there is our real estate transactions, and those tend to be intermittent. That's really the big driver in the other income line. But, again, you've got probably three quarters of some lingering affects of this [R&L] transaction.

And you're confident you can still get to $300 million in cash flow given you're behind that pace? Is the sense there's less Cap Ex to go in the fourth quarter versus the first three?

Absolutely. Now I remind you that there are some Katrina-related insurance recoveries that are part of that 300, but as far as the money we're spending, absolutely confident.

Okay. And one last question, maybe for Michael.

When you think of what the STB's doing with the fuel hedge hearings right now, do you have any real concern here that if you're switched to a different way of calculating it or what might come out of that could have a material impact to the way you look at recovery?

Ed, this is Michael, we really don't have that concern. One of the key findings of the STB is that the railroads did have the right to recover fuel cost increases. What they were talking more was the methodology. So as you know, that hearing is ongoing.

We will look, obviously, what the STB's opinion is as well as taking it to account market conditions, customer and constituent views. But we think when it's all said and done, we will have a fuel surcharge program that let's us recoup that increase in fuel costs once these hearings are over with.

I understand the unions and management are meeting as we speak. Any sense of timing, are we getting closer to an agreement?

Well, we are actively in discussions with them now. They're never the easiest of discussions, as you know, we're obviously looking for some productivity improvements in these discussions, but they are ongoing with the big unions at this point.

The big points we're talking about is healthcare costs and obviously work rule changes. We are committed to try to reach voluntary agreements with the unions and we think we're providing competitive wages and benefits.

Just to remind you, the Railway Labor Act does provide some pretty significant safeguards against any rail service disruption. I think in the last 30 years, there've only been six days lost to strike.

So we're in active negotiations. It's hard to predict exactly when those will reach conclusion, but both sides appear to want to make agreements, Ed.

Okay. Thanks for the time.

Thank you. Our next question comes from Jason Seidl with Credit Suisse.

Thank you. Good morning, gentleman.

Quick question here regarding your revenue per unit on the intermodal side. It's up 4%. How much of that being up 4% was just due to mix when I saw domestic volumes picked up a little bit from, say, second quarter levels [in] the decline?

Jason, this is Clarence Gooden. I'm not sure I know the answer to that from a pure mix standpoint.

Okay.

I guess a better way to ask what I'm trying to get at, Clarence, when you're going to be taking on new business on the intermodal front, should we look at it as you're going to take it all on that 4% average level, or are you think you're going to be able to get more than 4% revenue per unit increases going forward at the new intermodal business?

Well it would depend on the business and where it's originating and terminating from. On our transcon business, I think we'll get a lot more price there. On our domestic business on the core, there's pricing opportunities there, particularly where we're competing with trucks on a head-on basis.

On our international traffic, as we move to reprice it, we expect to be able to get price increases in what we've traditionally been saying, which is around 5 to 6%.

Clarence, would you say overall as we grow this business some of it may be lower revenue and pull down the RPU some, but the profitability level of that will be similar to the business we have today.

That will be definitely true on some of the shorter haul interchange business that we have that we call watershed business.

Okay. Fair enough.

A coal question as well. Obviously coal volumes are pretty strong in the quarter. How much of those volumes were sort of related to that new start-up plant that's coming on in South Carolina?

I'm sure you probably had some preshipments headed to them to get them started up and what should we think about that adding to 4Q as that plan opens up?

Actually, not much of that business in the third quarter was related to that plant. That plant had been building stockpiles all throughout the year in what would have been a normalized build for a start up utility.

Okay. That plant comes online this quarter though, correct?

That is correct.

Should we see a spike at all, or should it just be sort of just a normalized run rate?

I think you'll see a normalized run rate. Okay. Thanks a lot, gentleman.

Thank You. Our next question comes from John Kartsonas with Citigroup.

Hi. Just a quick question on your capital structure, I guess.

This quarter once again you hit, I guess, all-time low or multi-year low on your net debt ratio. How do you think about that going forward? And especially as your returns improve, do you think that you'll be able to get some more debt [in]?

Hey, John, this is Oscar.

I generally -- I think our go-forward approach will be of a balanced nature. And as you look at our debt ratios, I think we're in a pretty good place and it's certainly nice to have the dry powder there to be able to tap into it.

But I would forecast that we would stay around those levels from a debt, from a capital markets perspective, and continue to do the things we have been doing, obviously invest in our business and then return money to shareholders with regards to either dividends or much like we announced recently with the share repurchase program. Kind of a balanced approach across all those with probably less emphasis in the debt markets.

Do you think it's a case to be made to maintain the balance more on the dividend side or on the share buyback? I mean are you thinking about your payout ratio a little bit higher maybe going forward?

What I can say, again, I'll continue to say that we have a balanced approach and we'll obviously explore all those areas and that's certainly a benchmark, keeping up with the peers, keeping up with the S&P 500 with regard to dividends, those are all factors that go into our analysis, but, again, let's [inaudible] the balance issue to [inaudible] so there's no particular emphasis on any one of those, just a broader emphasis.

Okay. Thank you very much.

Thank you. Our next question comes from Scott Flower with Banc of America Securities.

Good morning, all. A couple of questions.

Clarence, could you give us some sense of where you are on fuel surcharge coverage, however you may define that. I know there are different ways of getting that, and what sense do you have in '07 of how much can that grow in terms of your coverage percentage?

Well, about 55% of all of our revenue now, Scott, is covered by our fuel surcharge and another 25% is covered by some form of fuel escalator.

At the RCAF?

Could be RCAFU. That gets us up to about an 80% coverage. We expect our fuel surcharge coverage going forward to increase next year.

As I probably told you this before, but since we implemented our fuel surcharge, we do not renew contracts without our fuel surcharge coverage in those contracts. So as contracts come up for renewal this year, they will all be renewed with the fuel surcharge provisions in them.

So is it fair to think that maybe you picked up three to maybe five percentage points of coverage next year?

That would be very fair.

And then I know on your volume outlook that you talked about 2 to 3% volume growth but obviously last year, I guess, volumes were down about 8%. So I'm just wondering, are you being very conservative?

Is this the function of you shedded some lower margin business and that comes into your calculations -- I'm just trying to get the square because obviously last year's fourth quarter the volume side was down, obviously, due to the hurricane impact but this year's growth, obviously, is growth, but it's against fairly easy comparisons. So I'm just trying to square those two items.

I think we said early on on our volume growth that we expected to grow this year, that we were down in that first quarter, we were flat in the second quarter, we've been up in the third quarter and then I think our guidance was we expected to grow 2 to 3% volume growth in the fourth quarter.

And then long-term, we still expect to continue to grow 2 to 3% and in our general freight business and in our intermodal business long-term, we expect to grow 5 to 7%.

And then one last question, maybe this is either for Michael or Tony.

Productivity didn't fully offset inflation and I guess ex fuel costs were up 4% and I know there's some smaller comparative issues in the Conrail line and volumes were up, too. How should I think about how you look at productivity offsetting inflation?

Do you think you can offset half, more than half? I'm just trying to get a sense of how much you can offset of the normalized cost inflation in your businesses as you continue to steadily move the bar up.

This is Oscar, if I could, let me take that one.

Historically, the railroad industry trying to overcome inflation was certainly a charge and a challenge that we all took on. What we're seeing today is some pretty sharp raw material increases and so the inflationary costs are running just a little higher than they have historically.

Now having said that, we'll continue to focus on productivity to offset that rising inflation and any of those things, so I think in general, you can expect our kind of a normalized total cost when you exclude fuel to continue to transform, kind of similar to what they've done this quarter in the near-term.

Okay. Very good. Well, thanks, all.

Thank you.

Thank you. Our next question comes from John Barnes with BB&T Capital Markets.

Hey, good morning, guys. Let's see, two things, I guess both for Clarence.

In looking at your fuel recovery, of that 25% of your business currently covered by some type of escalator, whether it's an RCAF or something else, how much of that business do you think you can convert over to a pure fuel surcharge and maybe get away from these other escalators?

John, as they come up for renewal, 100%.

Okay.

And then the second question I have is, we hear a lot about intermodal contracts and specifically coal contracts up for renewal over the next couple of years and the opportunity there on the pricing side. Is there any other commodity group that y'all are involved in that you see as good an opportunity on price as coal and intermodal that has a similar level or similar percentage of contracts in the next couple of years?

John, I think at least through 2007 we have pricing vibrancy in just about every commodity group that we have. We haven't been adding car capacity.

The fundamentals on the highway, in my view, have not changed. The driver shortages still exist, the issues that were around drivers that didn't want to be away from home for long hours still exist. The fuel issues around trucks as we go to different engines, as we go to different fuel sources for trucks that get less gas mileage and less efficiencies in the engines still exist.

The highway congestion and capacity issues still exist in the country. So I see the pricing vibrancy for the rail industry continuing through 2007.

Okay. All right. And then Oscar, maybe one for you.

Union Pacific came out and announced at their analyst meeting a significant ramp-up in their Cap Ex and we've gotten the question over what other rails could we see this out of. I know you laid out a very aggressive plan on certain projects that you were targeting for new customers and that type of thing.

Do you foresee the need to see that kind of ramp-up in your Cap Ex as well, or are you fairly comfortable with the run rate you're currently on in terms of Cap Ex?

John, thanks.

What we said last year was a 2.7 to $2.8 billion spend over '06 and '07 and I would expect that we would continue that so no additional ramp-up that we are planning. We'll give you the details, again, at our next quarter call, but there is no plan to deviate from those stated numbers at this point.

All right. Very good. Guys, nice quarter. Thanks for your time.

Thank you. Our next questions comes from John Larkin with Stifel Nicolaus.

Yeah, good morning. It's actually Stifel Nicolaus. First question is probably for Tony Ingram.

The on time departures and arrivals have really improved quite a bit, but, again, they were easy comparisons due to the hurricane. Looks like there's still a lot of room for improvement. What is your ultimate goal there, what's the timetable for achieving that goal, and what potentially could be the impact on improved operating margin if you were to achieve that goal?

Steve, our goal is to get above 90. We measure our on time performance to the minute and that is a goal that we push and strive for.

That also gives a big opportunity, if you get the train out on time, you get the other train in on time, it turns the power and the crews and the cars much, much quicker. That's our strive, to try to get it above 90%.

Any thoughts on how long it will take to get there and what the impact on the OR might be?

Well, I'd like to be there tomorrow, but we all know this is sort of a ramp-up. We did get a big kick-up this year. We've got our ONE Plan running extremely good. It will be in increment steps here as we ramp it up as we go forward.

Okay. Thank you. I had a couple of additional questions for Clarence, perhaps.

You mentioned there were some new train starts driving domestic intermodal growth. Were those the Schneider train starts and what percentage of the intermodal growth could be tied to those?

It was the Schneider train starts and I don't know right off the top of my head the percent of the intermodal growth directly attributable to that, but it was part of the growth.

Okay.

And then on the auto side, it seemed like during the third quarter there were some temporary planned shutdowns as well as some permanent production cuts and planned shutdowns. Do you have a sense for whether that volume may at least partially kick back in the fourth quarter in going forward with maybe the third quarter having been the low point?

I don't. We're not expecting a very robust fourth quarter or a very robust 2007 in the automotive business in general.

Okay. And maybe one for Oscar, just to finish up.

The way you calculated, Oscar, how close are you to earning your cost to capital and how much longer, if you're still below that target, do you think it will be before you achieve that target?

We're so close we can taste it. We're getting very close. We haven't forecast yet exactly when, but we have said, well, are striving to meet or exceed cost of capital so we're getting close to that point.

All right. Thank you very much.

Thank you. Our next question comes from Jordan Alliger with Deutsche Bank.

Hi, good morning. Just a couple of related questions.

Is there a level of economic growth where it does get more difficult to see the type of price increases you've been seeing, which particularly on the industrial side, where the economy does appear to be slowing?

And then secondly, tied into that, I know you mentioned the comments on trucks, but is there more, or could there be more price sensitivity on the intermodal side given the truck competitive aspects of it?

And the reason why I ask is, we have been seeing additional capacity, I think, come into the truckload sector. They have been under pressure from a volume standpoint. I'm wondering if that can trickle over into your intermodal business? Thanks.

On the first part of that question, is there some point which, if I understood you correctly, is there some point at which the economy falls to a certain level that impacts pricing. Was that the question?

Basically, yes.

Yes. I would say that in some of our markets, metals might be an example of that although metals has been very strong. They are linked to the economy.

There's other parts of our markets, agricultural markets would be an example of that where we're feeding animals. Ethanol markets would be an example of that where there's a constant demand for the product use.

Municipal solid waste, which has a constant demand for services regardless of the economy. Some of our aggregate markets that are tied into public paving projects.

Coal, which tends in these times to be a primary driver of electrical generation. Our food product lines that we haul, people eat when the economy goes down.

All of those lines tend to be recession resistant and so I'm not sure that answers your question entirely. I guess to sum it up, we've got some parts of the portfolio that would be subject to that but, frankly, we've got more than half that are not.

Your second question was around truck capacity and pricing. Our view of it is that truck capacity in the short-term, particularly in Class 8 trucks, has ramped up as companies have bought trucks in anticipation of the new engine laws at the first of the year.

Remember, you can have all the trucks you want, but if you don't have drivers, if your insurance is high, if you've got those kind of issues, highway congestion, it's not what it's knocked up to be. And we think you're seeing a temporary bubble there.

It is true that truck pricing will be more closely aligned with intermodal pricing, simply because of the nature of the beast there, but we've seen intermodal prices staying fairly stable.

Thank you.

At this time, I show no further questions and would like to turn the call over to Mr. Ward for any closing remarks.

Thank you. Appreciate you joining us for our call today and look forward to reporting good results in the fourth quarter. Thank you.

Thank you. This concludes today's teleconference. Thank you for your participation and have a great day and please disconnect your line. Thank you.