CSX Corp (CSX) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation's second quarter 2007 earnings conference call.

As a reminder, today's call is being recorded. During this call, all participants will be in a listen-only mode.

For opening remarks and introductions, 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 and good morning, everyone, and welcome to CSX Corporation second quarter 2007 earnings presentation.

The presentation material this morning that we'll be reviewing along with our CSX quarterly finance report and our quarterly safety and service measurements are available on our Web site at csx.com under the Investor section. In addition, following the presentation a webcast and podcast replay will be available.

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

Now 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 forward-looking statements.

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

Thank you, David, and good morning, everyone.

The second quarter results announced yesterday demonstrate once again CSX's earning power and momentum. Earnings per share were up 22% on a comparable basis to last year when you back out insurance recoveries and tax settlements from the prior period.

Our transportation businesses generated record second quarter revenues of $2.5 billion, a nearly 5% increase over 2006 and operating income of $603 million. Our operations are clearly in a rhythm and delivering great results in both safety and service. We expect continued improvement in both these areas and our people are not letting up.

Our safety focus and success are first and foremost about protecting our employees and the communities we serve. At the same time, financial benefits are also very real. As a direct result of our safety improvements over the past three years, we were able to take a second quarter $30 million reduction in reserves related to lower personal injury claims.

On the service side, not only are we seeing continued gains in our operating performance, but those gains are translating into higher and higher levels of customer satisfaction. Our improvements in customer satisfaction and service support strong pricing, with approximately 7% improvement in revenue per unit in the quarter.

And when you combine the underlying strength of our safety, service, and price performance with the ongoing productivity efforts in our operations, we continue to drive our operating ratio lower.

Our employees understand that we are establishing new milestones even as we achieve others. The second quarter demonstrates that our focus is clear and we are on the right path to achieve our goal of an operating ratio in the mid to low 70s by 2010.

Now let's look at our results, beginning with Tony who will discuss our focus on operational excellence. Tony?

Thank you, Michael, and good morning, everyone.

I'm pleased to report the team delivered strong results for the second quarter. First, safety results are outstanding and the positive trend continues. We're running the plan and key service measures continues to improve across the board.

Our customer sees these improvements and they gave us our highest ever rating in customer satisfaction. Productivity is also improving and working against inflation.

Let's look at safety in more detail. Slide 7 shows the excellent trend in safety continued in the second quarter. In the yellow box you see personal injuries at 1.04 for the quarter. This is the best performance ever achieved at CSX and it helped drive the improvements for the rolling 12 months.

Train accidents were 2.85 for the quarter. On a rolling 12 months they were down 22% to 3.09. The improvements in safety are outstanding, but we will not stop here. Our employees are committed to safety and reaching higher level of performance.

Let's turn to the area our customer sees, on-time performance. On-time in originations increased to 80% in the quarter, another all-time high for CSX, and for the rolling 12 months performance improved to 77%. On-time arrivals were 69% for the quarter and also improved for the rolling 12 months.

The train network is running well and our focus on plan execution is producing results. This trend will continue as we build on our success.

Looking at Slide 9, our asset turns also continues to improve. On average, the dwell was 24 hours in the quarter and 25 hours for the rolling 12 months.

Our terminals remain fluid and they're running the plan every day. Cars on line remained at a good level, 223,000 cars for the quarter.

Now let's look at another measure of network performance, velocity. Velocity improved to 20.4 miles per hour in the second quarter and a 20.1 for the rolling 12 months period.

The improvements in average velocity is a positive sign, but stable velocity performance is also important. Stable velocity shows the network is fluid and reliable and can recover quickly from service disruptions. In the end, stable velocity leads to more consistent service for our customers.

This brings me to Slide 11, which shows customer satisfaction. Each year we ask more than 2,000 customers to grade our performance on 15 aspects of service. For the most recent six months, our scores are higher than they've ever been.

It's very rewarding to have our customers recognize the operating improvements we work hard to deliver. Improved service to our customers is critical to long-term profitable growth for CSX. Just like safety, the work here is not complete. We target continuous improvements.

Turning to Slide 12, we're making real progress in productivity. The network is more efficient when we execute the plan. This is most evident in car hire, the time-based cost of using real equipment not owned by CSX.

In addition, through the ONE Plan, we continuously size our train plan and assets to meet current business conditions. Our process improvement teams are also manage a pipeline of projects to deliver productivity gains to help offset the cost of inflation.

Finally, we recently launched a new initiative called Total Service Integration, or TSI, to further improve customer service and productivity. We'll discuss TSI in more detail at the September investor conference.

Wrapping up on Slide 13, our plan is working and we'll continue to build on the solid foundation with leadership, discipline, and execution. The great momentum in safety and network performance will continue. We can achieve even better results.

We continue to raise the bar on productivity and the use of key assets. Finally, our customer will enjoy continuous improvement and service reliability.

Now let me turn the presentation over to Clarence to review the sales and marketing results.

Thank you, Tony, and good morning, everyone.

This morning I'd like to highlight our second quarter results, the primary drivers, and offer insights on what we see ahead for the remainder of 2007. CSX achieved another successful quarter of revenue growth in spite of the continued weakness in the housing and automotive sectors of the economy.

Revenues increased nearly 5% to a quarterly record of $2.5 billion, exceeding the prior year by $109 million, primarily on the strength of our pricing actions. Yield improvements of $164 million more than offset the impact of lower volumes. This continues our success in delivering uninterrupted quarterly revenue growth for more than five years.

As you can see on the next slide, the pricing environment continues to be strong. The line on this chart reflects the year-over-year change in total revenue per unit, which includes the impact of price, fuel, and mix.

During the second quarter, overall revenue per unit increased 6.9%. This increase is less than the rate we saw in the first quarter due to the impacts of fuel and mix.

The bars on the chart reflect the increase in price on a same-store sales basis, which excludes the impact from fuel and mix. Same-store sales are defined as shipments with the same customers, same commodities and car types shipped between the same origin and destinations. These shipments represent approximately 75% of our total base.

On this basis we achieved average overall price increases of 6.5% in line with the price increases we have achieved over the last seven quarters. Also let me remind you that in any given period, not all traffic is up for renewal.

These results reflect our continued focus on pursuing the highest yields on existing and future traffic, despite some temporal weaknesses in volume. Moving forward in 2007, we absolutely expect to continue our momentum in improving yield.

Now let's look at the factors driving volume change. Quarterly merchandise revenue of over $1.2 billion increased 5%. This, too, represents a new quarterly record.

This growth was driven by stronger yields in all markets as revenue per unit increased 9%, more than offsetting volume softness in several markets. Growth in agricultural shipments was favorable due to continued rapid growth in the northeast ethanol market.

We saw the most significant volume declines in our forest products, food and consumer, and emerging markets where the softness in housing reduced shipments of lumber, building products, roofing granules, and aggregates.

Let's turn to the next slide and review the results from coal. Strong pricing actions also drove quarterly coal revenues to a record $638 million, an increase of nearly 8%.

Continued strong demand for export coal during the quarter was offset by declines in shipments to utilities as eastern coal utility stockpiles have reached target levels. Although carloads were down nearly 1%, total tons shipped were favorable as we continue to ship more coal per carload.

Revenue per unit increased 9%, significantly offsetting the moderating volume. This reflects our continued focus on yields and we believe the favorable pricing environment in coal will continue.

Now turning to the automotive market's results. Quarterly automotive revenue of $223 million remained flat as revenue per unit gains offset volume declines.

North American light vehicle production for the big three continue to decline in the second quarter by 7%, as auto industry restructuring resulted in additional plant closures during the second quarter. This trend continues to more than offset the growth from current new domestics located on CSX.

Pricing actions resulted in a revenue per unit increase of 4% and the pricing outlook remains favorable going forward. Long-term, we feel well positioned with the big three and for continued growth in the new domestics.

Turning to our intermodal results. Quarterly intermodal revenue of $343 million declined 4% driven by mix and lower volume as declines in international traffic more than offset the increases in domestic traffic. International traffic is down 8% due to losses across a few accounts and the closing of our Kingsport, Tennessee, intermodal facility.

In addition, there were losses due to select steamship carriers withdrawing from certain markets. However, new shorter haul train service into and out of Atlanta, as well as other new dedicated train services, drove growth in domestic traffic by more than 8%. These new services will continue to be a catalyst for growth as the year progresses.

Price on a same-store sales basis increased over 4% across the intermodal portfolio, yet overall revenue per unit decreased due to the mix impacts from the shorter haul yet profitable traffic.

And taking a look at intermodal profitability, intermodal operating income was up 16% for the second quarter despite less volume and revenue as a result of pricing gains, the new profitable shorter haul service, and greater operating efficiencies. This resulted in a second quarter operating ratio of 79.3%, a 3.6 point improvement versus 2006 on a comparable basis.

And now let's take a look at the revenue for the third quarter. Overall, our third quarter revenue outlook is positive. Pricing strength will continue to be the key driver across all markets.

As you can see, in the near-term, revenue is expected to be favorable in six of our ten markets, neutral in two, and unfavorable in two. Coal, coke, and iron ore revenue growth will remain strong due to continued pricing strength despite volume challenges from tough year-over-year comparisons and high utility stockpiles in the east.

In contrast to the second quarter, the outlook for revenue and volume in automotive is favorable as vehicle production forecasts have improved and as we have moved beyond some of the initial unfavorable year-over-year comparisons from 2006. The revenue outlook for merchandise is generally favorable, although continued softness in the housing sector will impact volume and revenue in metals, food and consumer, and forest products.

The outlook for intermodal is neutral. Although we see continuing benefits from improved operations, our new services and strengthening in international traffic as we move beyond the third quarter of 2007.

Let me close by looking at the overall business environment. The economy is forecasted to improve in the second half resulting in growth for 2007 and 2008 in the range of 2 to 3%.

More importantly, we expect strong revenue growth to continue driven primarily by our ongoing pricing success. While near-term volumes will be soft, our overall volume outlook is improving.

We are committed to providing excellent service and value for our customers and let me again reiterate, we will not sacrifice price for short-term volume gains. This focus reflects our long-term vision of pricing to the market to support higher yields on existing and future traffic.

Thank you very much and let me turn the presentation over to Oscar to review our financial results.

Thank you, Clarence, and good morning, everyone.

On Slide 25, which represents our reported numbers, we recorded earnings per share of $0.71 for the second quarter, a decrease of $0.12 from the prior year. Going back to the top of the slide, in the quarter we saw Surface Transportation operating income of $603 million, reflecting improving operating performance and strong cost control. As a reminder, last year's results benefited from insurance recoveries.

Moving below the line, other income and interest expense are both relatively flat with last year while taxes are $21 million higher, primarily due to a benefit seen in the prior year related to the resolution of certain tax matters.

Turning to the next slide, let's look at our results on a more comparable basis. After removing the prior-year gain on insurance recoveries and income tax benefits, earnings per share on a comparable basis increased $0.13, or 22%.

Looking at operating income after removing the gain on insurance recoveries, our Surface Transportation business increased earnings $84 million, or 16%. Now looking at this result from a broader perspective on Slide 27, you can see that there are two key items affecting the year-over-year comparison of our operating income.

The first is the cycling of our now-expired fuel hedge position, which increased last year's second quarter results by $19 million. The second is a favorable adjustment to our personal injury reserves, which reduced expense by $30 million in this year's quarter.

Now as a reminder, we evaluate our personal injury reserves twice a year based on independent actuarial assessments analyzing historical and recent trends in claims and settlements. This reduction reflects the significant improvement in our safety record over the past several years.

Absent these two items, our core earnings power increased $73 million, or 14%, setting an all-time high in comparable operating income despite the softer economic environment.

Now let's walk through the details of our Surface Transportation results on the next slide. As Clarence discussed, we have seen more than five years of uninterrupted top line growth. In total, continued strength in yields more than offset our decline in volume, resulting in nearly 5% growth for the quarter.

On the cost side, reflecting the impact from lower volumes, stronger operations, and the favorable adjustment to our personal injury reserves, total expenses increased 1%, or $25 million for the quarter, the details of which I'll review over the next few slides. The net result was a second quarter operating income of $603 million and an operating ratio of 76.2.

Let me start our expense review with labor costs. On Slide 29, labor and fringe, which is our largest expense category, increased $26 million, or 4% over last year. The increase was primarily driven by wage and benefit inflation of $26 million, as well as costs associated with the ratification of a labor agreement in the quarter.

However, as a short-term increase in expense associated with this agreement, we expect long-term benefits as compensation for our locomotive engineers is now more directly linked to our corporate objectives.

These cost increases in labor were partially offset by a reduction in train crew head count due to lower volume and our continued focus on productivity and cost control. Looking forward and on a full-year basis, we continue to expect our labor and fringe expenses to increase less than inflation as we achieve our productivity objectives.

Moving to the next slide. On MS&O, these expenses increased by $18 million, or 4% over last year. This was driven by continued higher inflation, an increase in the allowance for non-freight related receivables and various other items.

As I previously discussed, these increases were partially offset by the $30 million reduction in our personal injury reserves, reflecting the significant progress in our operations team has achieved in making safety a way of life.

As we've stated in the past, only about 20 or 30% of our MS&O expenses are directly tied to volume. The remaining costs are more indirect in nature, such as contracted services, cost of risk and infrastructure and equipment maintenance. So in the near-term, you can expect the quarterly run rate on this line to continue growing at 6 to 8% on a year-over-year basis.

Let's move fuel on the next slide. Overall, fuel increased only $1 million versus last year.

The cycling of a $19 million hedge benefit from '06 was mostly offset by a reduction in average fuel price of $12 million, a decline in volume of ton miles, and a continued improvement in fuel efficiency. This improvement in efficiency directly reduced fuel consumption by over 2 million gallons for the quarter.

In further reflecting our commitment to the environment and to improving fuel efficiency, in locomotive process improvement team, a pit team was recently awarded a bronze medal from the American Society for Quality for significant improvements resulting from a company-wide fuel conservation initiative.

Now let's go to the next slide and talk about rent. Equipment rent declined 17%, or $23 million driven by a reduction in car hire expense. Primarily driving this reduction were lower volumes in our merchandising intermodal markets and the continued improvement in operational fluidity and asset utilization.

Additionally, we experienced a favorable impact of $7 million related to the settlement of car hire expenses with other railroads. If you exclude the favorable impact of these settlements, on a go-forward basis, you should expect our rent expense to move with our business volumes and to continue to benefit from improvements in asset utilization.

Let me review the remaining expenses on the next slide. All other expenses increased $3 million versus prior year. The driver of this increase is depreciation, which was higher due to a net increase in our capital asset base.

Partially offsetting this increase are lower depreciation rates as a result of an equipment life study completed in the quarter. As a reminder, railroads are required by the Surface Transportation Board to complete a periodic review of their assets.

Equipment is reviewed every three years while track and other assets are reviewed every six years. Our depreciation rates are being driven lower, reflecting longer lives and higher salvage values for our rail cars and locomotives.

With that, let me update you on how we're managing costs for the long-term. On Slide 34, as our operations have significantly improved, our time horizon for identifying and achieving productivity initiatives is lengthening.

We have established both near-term and long-term productivity and effectiveness targets, utilizing cross-functional process improvement teams. These teams evaluate processes from end to end and are responsible for developing a pipeline of projects looking out several years into the future.

Core to our approach in managing costs, we are constantly benchmarking ourselves against the best in class. Our focus on cost management will be a key enabler in achieving an operating ratio in the low to mid 70s by 2010.

Now on the next slide, let me update you on how we continue to return value to shareowners. Our repurchase program is consistent with our balanced approach of investing in the business and returning value to shareowners through share repurchases and dividends.

In addition to representing approximately 15% of current market cap, this is the most aggressive share repurchase program in the industry. We are on track for completing the program by year-end 2008.

To date we have already completed over 20% of the program, including the repurchase of approximately 12.3 million shares for nearly $550 million in the second quarter. As we've said before, we will continue to have a bias for early repurchases.

In addition to the share buyback program and consistent with our balanced approach, we recently announced a 25% increase in our quarterly dividend to $0.15 per share, effective with the third quarter payments.

Let me wrap up on the next slide. The actions we have recently taken to increase capital investments, share repurchases, and dividends reinforce our view of the Company's long-term growth prospects.

As a reminder, we have updated our long-term financial targets expecting to deliver double-digit growth in operating income and earnings per share through 2010, growing off a record 2007 base. Over this time frame, we also expect to improve margins to record levels and continue delivering returns on capital that exceed our cost of capital.

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

Thank you, Oscar.

It's my privilege every quarter to talk to you about the renaissance in our industry and the excellent value CSX employees are delivering to our shareholders, to our customers, to our communities, and to our country.

In the three years ending June 30th, CSX investors have seen the value of their stock nearly triple and have made more money than investors in 95% of the S&P 500 companies. We're proud of that.

Companies create value when they have something compelling to sell. For some companies, that means changing the flavor of the soft drink, for others it means delivering a cell phone that plays music and surfs the Internet.

For railroads, as you know, the value proposition is quite different. We meet the needs of the entire nation every day, not just desires or preferences, but real needs.

CSX owns an immense 21,000-mile system. Every day we maintain it, we expand it to meet new demands and we make it safer. Along our 21,000 miles we transport coal to light American homes, grain to feed livestock and poultry, military equipment to protect our homeland, and even soft drinks.

We're also there for the safe movement of passengers and commuters who ride on our tracks across the country and through cities like Boston and Washington, D.C. What many people don't know yet is that railroads, which are funded by private industry, are becoming a greater and greater force in bringing solutions to even more public needs.

As environmental protection becomes more important and the highways more crowded, America is turning to railroads. We are three to four times more fuel efficient than trucks, which dramatically reduces emissions. Railroads also take traffic off the nation's highways and deliver the safest form of ground transportation available.

We meet needs. We create value for many constituencies and that translates into values for our shareholders.

Large freight railroads spend more than four times as much on capital for every dollar of revenue than all U.S. manufacturing companies on average. Let me repeat that, four times the average.

To invest at this significantly higher level, it's critical that we have ready access to capital supported by an investment grade credit profile. In order for that to be possible, CSX must also sustain a disciplined and balance approach to managing our capital structure.

So what does that mean? First it means continuing our excellent financial performance. To that end we anticipate double-digit gains in our key financial measures between now and 2010.

Second, it means repurchasing shares when it makes sense. We currently have the most aggressive repurchase program in our industry.

Third, it means paying excellent dividends to our shareholders. Our announced increase, effective in September, will triple our dividend in just two years.

And finally, a balanced approach means investing consistently and responsibly in the CSX transportation network to meet growing demand. Our balanced approach provides generous rewards to our investors in both the short and the long run.

So before I turn it over to questions, I'd like to thank our shareholders who are attracted to a company with a balanced, long-term strategy and a focused, accountable, and highly motivated team. So with that, we'll take your questions. If you would please identify yourself and your affiliation for the benefit of our audience.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Ken Hoexter with Merrill Lynch.

Hi, good morning.

Great, great results and good to see that things are really on track on the turnaround. And Mike, before I get to some of the earnings questions, I just have a question on the big picture.

There's an article up in Canada today talking about a potential bid for CP and that potential for them dividing the network up into a network operating company and a physical asset and then the rail operating entity. Can you talk about, as you talk about how looking at the Company and ability to get certain leverage, can you talk about whether something like that makes sense in ability to get more leverage on top of the Company to get the returns that you desire versus operating as a full entity? Because I know we're getting a lot of questions on that this morning.

Well, Ken, as I think you know, as a matter of long-standing policy, we usually don't discuss long-term strategic assessments. But having said that, I think that our current business model is the right business model for CSX.

This company and it's committed employees have brought excellent results and value by just about any measure you can think of. I mean tripling in the last three years is, I think, pretty darn good, and as I said, we're proud of it. And I think you can really look forward for us that we're going to continue that and we're going to continue that at a strong pace.

Okay. Great.

Then on the quarter, Clarence, you noted that yields were up 7% or 6.5% in line with the same-store level. What level do you target as the annual increase level in some of the long-term contracts? Is it in that 6.5% range, is it a little bit lower? Kind of on an annualized inflationary level, growth level.

Well I think, Ken, what we've said in the past is that we expect in 2007 that our same-store sales price increase is going to be in the range of 6 to 7% and next year in the range of 5 to 6%.

Okay.

And then on the coal, you mentioned that with some of the newer cars you're getting more, and that's why you saw some of the levels of volumes decrease a bit. Do you bill buy the tonnage or by the car? So I'm just trying to understand who benefits from the increase capacity of the cars?

We bill by the ton.

Okay.

And then lastly on the intermodal side, you said you decreased international traffic, you closed the Kingsport, Tennessee, terminal. When do you annualize that? Was there a large customer that moved off your network?

Can you talk a little bit about the international side? Because I understand it some of the eastern ports are actually seeing some benefit from the tightness or capacity going on on the west coast, they're moving more to the east. I just want to understand if you could see some of that improved volume flow on the east coast.

We closed the Kingsport, Tennessee, terminal on April 1st. It was a mutually agreed closure by us and our customer. It was relatively short hauled international freight moving to the port of Charleston and it's right in the middle of our coal field, so we had a higher and better use, if you will, for that -- for those train slots that were moving down that Irwin, Tennessee gateway.

Great. Thanks for the time.

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

Good morning, guys.

Good morning, Ed.

Can you give a little bit more detail around the labor? You talked about there were some costs related to the ratification of some contracts. Can you talk about what those costs were and how we think about those same costs in third quarter and fourth quarter versus second quarter?

Ed, this is Oscar.

The engineer ratification cost in the quarter was approximately $12 million. That is by and large a one-time ratification cost and don't necessarily see increases in the further quarters. But we do see, obviously, I think it's a great win for both teams, as we have more and more of our work force tied along with management to the Company's objectives.

What other contracts are ratified and do you expect a similar kind of drag from those as they get signed or have you accrued for some and we could even see benefits?

I think it's a combination of all of that. There is always several things that are out there working, the timing, which we can't forecast. We do tend to accrue on a general basis what we expect and then the ratification costs and such all of that are included as part of that. So as they happen we'll let you know and work through them.

So average comp being up 4.5 in the quarter, we should look at that as there's about $12 million in there that's unusual?

Yes.

You also talked about the asset life study on the depreciation side. Can you give us some more details of what's changed in terms of how you're looking at depreciating the assets going forward?

I think the way to look at it financially, it'll slightly decrease the rate of increase that you're seeing because of the increased Cap Ex. It's about 4 or $5 million a quarter going forward, offsetting, again, the higher cost of Cap Ex.

Right. So that goes forward and then that will grandfather in second quarter of next year kind of thing?

Exactly. If you mean we will cycle it.

Yes. You'll cycle it. That's what I meant by that.

Also, the $30 million insurance reserves that you talked about in MS&O. How do we think about that next quarter? Is that something that we'll see third quarter or not again?

Yes, I think because it's a long-term actuarial adjustment, it does have some ongoing benefit. It's about $1 million or so per month, so 3 to $4 million a quarter.

Okay. That's on top of the 30 this quarter or the 30 was one-time this quarter and then 3 a quarter going forward?

Exactly. It's 30 one-time and then a small improvement on a go-forward basis.

Okay.

Can you talk a little bit, Clarence, about the contracts and what's been repriced? If you look year-to-date, what percent of your contracts have repriced that had not repriced early '04 at this time?

Ed, we've got about 15% of our outstanding contracts right now, in terms of revenue, that have not been repriced since 2004. Everything else has been touched a minimum one-time and in some cases three and four times.

So that's left as of now, but can you talk about from January until now what was repriced, give or take?

I don't have that number with me.

Okay.

Directionally, where truck pricing is down, how should we think about you going forward when you compete with truck? If truck pricing stays down for a while, are you willing to live with negative volume for a while to keep the pricing up, or should we think at some point you've got to manage the volume yield on that domestic piece a little bit?

No. We're planning on keeping our focus on our pricing and in the short-term we'll just have to ride the volume out.

Okay. Thanks, guys, for the time.

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

Yes, good morning.

Good morning, Tom.

I wanted to touch on the pricing and then also a little bit on intermodal. Can, Ed asked you about the truck pricing. What about competition in the spot market with Norfolk Southern? Have you seen any change in that dynamic as a result of some slow volumes for a few quarters?

We have not. We see good, strong pricing all through the rail system.

Okay.

On the intermodal side, can you talk, I guess, a little bit about the medium-term outlook for growth on that and perhaps touch on the new service with the southeast service with Burlington Northern, how many trains a day are running now and kind of the outlook for further growth from that service?

Tom, we're running two a day. They are full in both directions. We may well have to add a second train here in the fall peak, if the fall peak does what we hope it does, hope it will and expect that it will do.

And as you saw in our numbers there, our domestic volume in general is up about 7, 8% in the quarter so we feel good about the domestic growth, you know, in the third quarter.

Okay.

So that service is meeting your expectations, it's coming in as you would have expected. And what about the international? You talked about closing that terminal in Kingsport, which seems to make sense.

Is that, I mean should we look at the run rate for international in second quarter and expect that to continue for a couple quarters as a result of the closure, or are you optimistic that that international volume growth would pick up a bit in third and fourth quarter and perhaps be positive looking out a few quarters?

You can expect that volume growth in international for three more quarters to reflect the loss of that Kingsport, Tennessee, business which was about 25% of the total international volume that was down. As we move into the fall peak and into the strong seasonal shipping business in international traffic, we expect that will grow some.

Is there anything else going on in international driving that softness or is it just kind of a weaker market in addition to the closure?

Well, some of the steamship lines, as you're aware, pulled out of certain points. You would know that as the IPI, the Inland Point Intermodal traffic. And that traffic in turn moves as domestic traffic.

Right. Okay. Great. Thank you for the time.

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

Good morning, guys. Congratulations on a nice number. A couple things on kind of productivity.

Tony, can you talk a little bit about your trends in terms of, have you been able to, you know, with the safety improvement and some of the improvement in on-time originations and arrivals, have you been able to do anything in terms of train size? Are you seeing a significant increase in cars per train, train starts, anything like that? And where do you think those numbers can go?

Well, John, yes, we've seen some improvement in our train size, 2 or 3%, primarily because we've taken out a number of trains and shrunk some of the network trains that we operate on a daily basis. Also, with the automotive being a little weak, we've taken some trains out in that line which has added cars to other trains.

Okay.

And how much more do you think you have on that front or do you think you've really exhausted your ability to continue to improve that?

Tom, we're raising the bar every day. We're not satisfied where we are, we're looking for a few more every time we run a train.

Okay. All right. Very good.

Oscar, can you give us an idea, average price per share on your repurchase during the quarter?

About $44.55ish.

Okay.

I think if you just do the math on the 550 and 12.3 million shares that should be $44.50.

I wanted to make sure it wasn't skewed by a move or anything in the stock.

The other question on that front, do you know, I'm just trying to get a sense, do you know how many shares a day you're allowed to purchase? I know it's a rolling kind of thing, but right off the top of your head, I mean do you know what the maximum number per day you can buy is?

I don't.

John, my recollection is no more than 25% of the last two-week average.

All right. Very good.

And then Clarence, lastly, just some of the follow-up on pricing. Of that 15% of your outstanding contracts that haven't been repriced since '04, do you have a feel for how many of those contracts -- what percentage of the remaining business that hasn't been touched, how much of that are we talking about that hasn't been repriced in ten years?

Is it some of that that's more in shorter duration since it's been touched, or is it half of it that hasn't been touched in ten or 15 years? I'm just trying to get a sense for, you know, of the remaining piece, what's the magnitude of increase we may see.

Well, I really don't know how much of it hasn't been touched in ten years because I don't look at it that way. I look at it, when am I going to touch it. The principal and preponderance of that will be repriced in 2008 and 2009.

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

Thank you.

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

Good morning, all.

Good morning, Scott.

Wondered if I could get a little color. Clarence, I know that in addition to the charts you show that in the past you've been able to break up RPU as a percentage basis between mix and price and fuel surcharge. I'm wondering if I could get that sense from you now for this quarter?

Well, as you know, we transitioned, Scott, to a new mileage-based program that's got a slightly different trigger point. So we're focusing on that same store sales perspective, which we've shown you now for the last several quarters. So the same-store sales is up 6.5% and the RPU is up 6.9 and the difference in the two is due to fuel and mix.

Okay. All right. And then what is your coverage on fuel surcharge between fuel surcharge and RCAP currently?

85%.

Okay.

And then I'm wondering, and you may have answered, I just want clarification, but you've mentioned, obviously, the Kingsport facility and then you also, I think, in your comments talked about international account losses. Was that the Kingsport facility you're talking about, or were there other contracts that moved away?

There was a couple certain lanes that shifted away.

And that was what you were talked about in terms of the IPI changes?

That was part of it.

Was some of the other business did it walk away just based on price or did it move just in terms of where it embarked into the country in terms of broader changes by the steamship company?

It moved by where the steamship lines actually routed the freight.

Okay. All right.

And then, I guess the last thing I had, maybe this is for you, Michael, is just obviously, there have been some other industry settlements. I'm just wondering where does that leave the industry relative to the remaining employee groups that are still outstanding in terms of labor contracts?

As you probably know, Scott, we've reached with the LRBC, the Rail Labor Bargaining Coalition, which is a combination of seven unions, six of those ratified, the seventh is out for a revote, it's very close and they think it will pass and that will be back in August. That will take care of about 50% of the industry's employees.

We're currently in discussion with a TCU, or clerical-led coalition for another five unions. Those discussions are occurring at this point and we're hopeful that they will follow the pattern set by the beginning 50% and then finally we'll have the UTU, which would be the last to come this round.

Okay. Thank you.

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

Good morning, gentleman.

A quick question about the personal injury reserve adjustment. You said that you do a review two times a year. If the trends continue on your safety record, should we expect another adjustment the next time that you guys look at this?

It's difficult, this is Oscar, to forecast that. There are many issues that go into that adjustment, but clearly, our best driver of that that we control is continuing that great safety record. And so that's what we focus on and then as the third party actuarials do their work, the resulting number is what we work through.

Okay. Thanks, Oscar.

Also, second question here. You talked about some of the long-term productivity targets. Can you give us a little bit more color behind that in terms of what they specifically are?

I think that the focus that we're trying to articulate is moving from kind of within year, within quarter kind of initiatives to a longer-term time frame as Tony and his team get some of the (inaudible) they've been getting, the decisions for moving longer-term are important that we look at our investments, our tools and resources and training of our much longer-term horizon. So it's the same basic issues, running the railroad and efficiency and productivity, but just on a longer-term basis.

So there's nothing, Oscar, that you guys specifically have in terms of, you know, here's our goals for train speeds, here's our goal for producing recrew rates, terminal dwell?

Every initiative has both an efficiency and a productivity measurement that we monitor and work through. We don't necessarily talk about those publicly, they're more internal documents. But, yes, every initiative has a very specific objective that's measured and monitored by the executive team.

Okay.

And clearly a key to getting to that operating ratio to the low 70s.

My last question here, guys.

Just related to the economy, everyone's talking about a second half turnaround, but have you guys started to see anything that would cause you to believe that we're starting to see it move in the right direction in terms of your customers and your traffic?

Jason, this is Clarence Gooden.

Hey, Clarence.

We're seeing, you know, in certain segments of the economy, as I mentioned in our agricultural business, in our ethanol business is strong, our chemical business continues to be strong. We put our intermodal business in a neutral sort of category.

Our coal business is sort of flat, moving there, and we still see issues in the housing sector. But overall, it looks to us like it's slightly trending up as we move into this second half.

Okay. That's good color. Thanks a lot, guys.

Thank you. Our next question comes from William Greene with Morgan Stanley.

Hi.

I'm wondering if you guys have a sense for how much of your volume change is due to the economy and how much might be due to yield management efforts, the whole pricing story?

I would say the preponderance of our volume change was in the -- was due to the housing and automotive sectors, mainly. And we had some decline in our metals business because of the inventories building up as a result of the automotive sectors, but in general, if you saw our other markets were fairly good as we moved in.

Okay. So it doesn't seem like the pricing is chasing volume off the rails is what you're saying?

No, I don't think so.

Okay.

And then if we look at the ROIC target that you talked about, Oscar, how do you compute that cost of capital? Do you use regulatory definition or you use Cap M or some other metric?

Cap M.

Okay.

And then just lastly in terms of a productivity metric, we often look at carloads per employee and that's been falling for, I don't know, six, seven, eight quarters, something like that. How should we think about that going forward?

Are you going to be able to start to drive that higher? Do you go through attrition or is this a number that just has to wait for volumes to recover?

I think as the volume comes back, I think that will improve that metric.

Okay. So we still will kind of hold on to what we've got here just because of the regular attrition.

They'll move with volume.

Okay. Thanks.

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

Good morning, gentleman.

Good morning, John.

Just had a question.

I'm thinking back to the session that you held at the New York Stock Exchange, I guess, coming up on a couple years ago where you laid out a very coherent plan that envisioned, I think it was 2 to 3% volume growth over a five-plus year period. And since that time, the economy has softened and volumes have turned negative.

As you look forward here in your plans through 2010, can you give us a sense for how you see volumes trending? When do you think the year-over-year comparisons will turn positive? Will they tend to gravitate back to that 2 to 3% level or do you think they'll maybe initially ramp back a little faster than that so that the long-term five-year average might be more like 2 to 3%?

And then as a follow-on to that, will that return to tonnage growth make Tony's job a lot easier in terms -- or a lot more difficult, I should say, in terms of continuing to show such dramatic improvement in the operating metrics?

And then lastly, will there be additional capital projects that will be needed to accommodate that growth beyond the Hudson River corridor and the [L&N] improvement that I would gather are nearing completion?

John, I hope you didn't think all those questions up by yourself. On the volume going forward, if the housing hadn't of hit us as hard as it did as an industry and the automotive downturns, we could have had much better volume here.

I expect that as the housing starts to come back sometime in late 2008 and all, you'll see the volume start to ramp back up. If we have a hot summer like we're having and hot nights and get a good electric burn on our coal, you'll see our coal business do good.

With the dollar staying as weak as it is right now, you'll see our export coal volumes stay strong and I wouldn't be surprised if you didn't see some of the soybeans and ag products being exported as a result of the weaker dollar. So moving forward into the out years and out through 2010, I think we're on target to see our 2 to 3% annual growth as we've outlined.

Will there be a catch-up do you think initially, or are we just going to gravitate back off the lower base to a 2 to 3% growth once we return to normal?

Unless we have just some quantum jump in the economy, it'll be a glide.

Okay.

Tony, do you want to address the operations question John had?

Yes. John, addressing the capital, as we indicated there in I think it was 2005, we had a two-year program to build some capacity between Chicago and Jacksonville and we're on target to complete that this year. We're seeing some improvements and we'll look at that as we go forward.

We are planning long-term to look at different capital improvements based on the outlook of business to come. And the assistance with our new program, our total service integration that we'll share with you guys a little later in the year will be a great tool on looking at how we lay out our capital program going forward.

Thank you very much.

Thank you. Our next question comes from John Kartsonas with Citigroup Investment Research.

Hi. Just a quick question for Oscar.

As you look at your $3 billion share buyback program, probably you will need (inaudible) debt markets in the next year and a half here. Any thoughts on whether that's going to be a gradual process? Like a certain amount per quarter, or is it going to be a one-off like the second quarter?

John, are you talking about the debt?

Yes.

Usually we tend to do that in relatively large tranches as opposed to scatter them over time. That's been our historical trend anyway.

Okay. And any thought on your cash balances, using some of that maybe?

We continue to use a balance of, obviously, cash on hand and other methods, but a lot of it will be fueled by debt.

So you'd expect like (inaudible) million to stay relatively flat?

I'm sorry. Say that again?

Do you expect the $800 million you have on the balance sheet to stay relatively flat?

I think it will go down a little bit.

Okay. Thanks.

Thank you. Our next question comes from Salvatore Vitale with Calyon Securities.

Hi. This is Amy Young from Calyon Securities in for Sal Vitale. Most of my questions have been asked, but just a couple of questions on some safety costs.

As we think about modeling out safety improvements, what level of cash costs should we expect to model out in the second half of '07 and 2008? Any color you can add on that?

Amy, safety costs are a very broad swath of costs across our entire P&L. We really -- it's really difficult to forecast that on an independent basis. So what we try to give you is sort of broad coverage on each of the individual line items, which we did today, it's the labor, MS&O, rent and such and that's probably the best guidance we can provide you at this time.

Okay. Thank you.

And back on to the yield of 7%. Is there any way you could quantify how much of that was mix? I'm not sure if that was --

No, Amy, as I mentioned earlier there to that question, we had transitioned over to a mileage-based program that's got a fuel surcharge that's got a little bit different trigger point, and our focus has tried to stay on a same-store sales perspective, which you may have seen for the last two or three quarters. So our same-store sales were up 6.5% and that RPU was up 6.9. So the difference in those two is both fuel and mix.

So the true price increase was 6.5

True price was 6.5.

Thank you. Our final question comes from Donald Broughton with A.G. Edwards.

Good morning, Donald.

One moment, please. Mr. Broughton, go ahead.

Thanks.

Can you give us some insight into how the April 26th transition to the mileage-based fuel surcharge program went, and really any insight into how it went on a commodity-by-commodity basis?

Donald, it went very well. We had essentially no problems. As our contracts have renewed, we have taken the customers to the newer mileage-based fuel surcharge. I'm not aware of any issues that we've had in any of our commodities.

And it doesn't necessarily affect the deregulated commodities, right? They continue to operate on the old program?

That is correct.

Of course, of course. But obviously it does affect a number of them.

And can you give us a quick update on the FRA investigation, a status update and how, if any, it has changed your Cap Ex allocation plans?

Yes. We've been working very closely with the FRA over the last three, four months and I think they're very pleased with the programs we're putting in place. A lot of it has to do with one, behaviors and making sure that we're doing things in a safe manner. We've engaged in a number of programs with them.

The spending side of it is not real big, Donald. It's deploying some technology over the next couple of years, detection technology, which are not overly expensive. So I think it's more around putting good processes, good programs in place more than huge capital infusions required.

And I think the FRA is very pleased with the program we have in place and the progress we're making, and as Tony alluded to, this is, last quarter was one of our safest quarters ever.

Fair enough. Thank you, gentleman.

Thank you.

Thank you, everybody, for joining us today. I think that concludes our call.

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