CSX Corp (CSX) 2011 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation third-quarter 2011 earnings 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, Vice President of Capital Markets and Investor Relations for CSX Corporation. Sir, you may begin.

Thank you, Lori, and good morning, everyone. Again, welcome to CSX Corporation third-quarter earnings presentation. The presentation material that we will review this morning, along with our quarterly financial report, our safety and service measurements, are all available on our website at CSX.com under the Investor section.

In addition, following the presentation a webcast and podcast replay will be available on the same website.

Here representing CSX this morning are Michael Ward, the Company's Chairman, President, and Chief Executive Officer; Clarence Gooden, Chief Sales and Marketing Officer; David Brown, 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. You are encouraged to review the Company's disclosure in the accompanying presentation on slide two. This disclosure identifies forward-looking statements and risks and uncertainties that could cause actual performance to differ materially from the results anticipated by these statements.

In addition, let me also remind everyone that at the end of the presentation we will conduct a question-and-answer session with the research analysts. With nearly 30 analysts covering CSX, I would ask as a courtesy for everyone to please limit your inquiries to one primary and one follow-up question.

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

Thank you, David, and good morning, everyone. Last evening CSX reported record third-quarter earnings per share of $0.43, up 19%, in a moderating economy. Revenues were up 11% from the prior year to nearly $3 billion with increases across all major markets. These results reflect the compelling value of freight rail transportation and recoveries associated with higher fuel costs.

At the same time, we invested in additional resources to enhance customer service. As a result, by the end of the quarter service reached the higher levels achieved in 2010 and we have positioned ourselves better for the future.

From a financial perspective, CSX delivered third-quarter operating income of $878 million and a strong operating ratio of 70.4%. The underlying fundamentals of our business continue to support our aspirations for the future.

In the near term that means the continuation of steady volume growth and financial performance. We remain highly committed to a 65% operating ratio by no later than 2015, and we fully expect that this will be achieved. Longer term the outlook for freight rail transportation remains attractive as the population grows and the need for cost effective and environmentally-friendly transportation solutions becomes even greater.

With that let me turn it over to Clarence to discuss our top-line results in more detail. Clarence?

Thank you, Michael, and good morning, everyone. Positive trends continue in the economy, although at a more moderate pace. Amid the uncertainty associated with the current environment, discussions with CSX customers and key leading indicators continue to point to growth in most of the markets that we serve.

Looking at the charts on the slide, the Purchasing Managers Index registered a reading of 51.6 in September, indicating a continued expansion of the US manufacturing. Please recall that a reading above 50 indicates expansion. At the same time, the Customer Inventories Index registered a reading of 49, indicating that respondents believe that inventories are still low.

Overall, transportation demand in the markets we serve continues to support profitable growth and CSX remains committed to delivering the value of rail transportation for our customers through a safer, more efficient, more reliable service product. Now let's turn to the next slide and review the results.

CSX revenue increased 11% to nearly $3 billion. As you can see on the chart, volume increases drove $20 million of the year-over-year growth in revenue. Also the combined effect of rate and mix accounted for $153 million of the increase, reflecting yield gains across all markets as we continue to sell the compelling value of rail transportation.

Finally, as you look further to the right, increased fuel recovery of $125 million in the quarter is helping to offset the impact of higher fuel costs. Let's turn now to the next slide and take a closer look at the volume growth.

Total volume increased 1% versus the same period last year. Merchandise, which accounts for 40% of the total volume, grew 2% reflecting gains in the majority of the markets that CSX serves. Intermodal, which accounts for 36% of the volume, was flat as domestic growth was offset by weakness in the international segment.

Finally, coal, which accounts for 24% of the volume, declined 1% reflecting strength in exports that were more than offset by the continued softness in demand from electric utilities. I will provide more detail on each of these markets after a brief discussion of changes in revenue per unit.

Now, turning to slide nine, revenue per unit increased 10% to over $1,800, driven by a combination of price and fuel recovery. Same-store sales pricing increased 7.1%. Recall that same-store sales are defined as shipments with the same customer, commodity, and car type, and the same origin and destination. These shipments represent approximately 75% of the CSX traffic base.

Finally, increased fuel recovery, a result of higher fuel costs in the quarter, also contributed to higher revenue per unit.

Now let's take a look at each of the major markets that we serve, starting with coal. Coal revenue improved 15% driven by the increase in revenue per unit, reflecting improved yield, higher fuel recovery, and positive mix.

On the domestic side, utility demand remained soft as electrical generation was flat in the Eastern United States. In addition, natural gas prices remained at low levels leading to continued displacement of coal at some utilities.

Export coal volume grew year over year as demand was strong for US metallurgical shipments to Europe and to Asia and to South America. Looking ahead export coal volume is expected to be in the range of 40 million to 42 million tons for 2011. At the same time, domestic utility challenges are expected to continue due to low gas prices and utility stockpiles that remain slightly above target levels. As a result, overall coal volumes are now expected to remain soft in the fourth quarter.

Now turning to our Intermodal results. Intermodal third-quarter revenue increased 16% to $369 million versus 2010, driven primarily by an increase in revenue per unit. Domestic volumes were up 5% as the overall truck market remains tight and higher fuel prices encouraged over-the-road conversions. International volume declined 4%, largely due to difficult comparisons from an early peak shipping season in 2010 versus a later, more moderate peak shipping season this year.

Turning to revenue per unit, Intermodal had higher fuel recoveries and increased yields in both sectors resulting in a 15% improvement versus the prior year. Looking at the fourth quarter, we anticipate growth to continue due to stronger imports and as new markets and lanes encourage organic growth and over-the-road conversions.

Finally, our strategic investments, such as our new Northwest Ohio intermodal facility and our National Gateway initiative, support long-term intermodal growth by broadening capacity and improving transit times and service reliability.

Turning to the next slide let's look at the merchandise markets. Overall, merchandise revenue increased 10% driven by a 2% volume growth and a 7% increase in revenue per unit. Volume grew in five of the eight markets led by metals, forest products, and automotive.

In metals, increased shipments reflected the strength in both the automotive- and energy-related markets. Forest products increased shipments of pulp board and lumber were the key drivers. And finally, in automotive vehicle production grew 5% during the quarter.

Volume declined in two markets with most of the decline occurring in the agricultural products where reduced demand for feed shipments was the result of limited supply, higher corn prices, along with decreased production from producers of poultry and pork. Revenue per unit increased due to higher yields and higher fuel recovery. Looking forward, merchandise shipments overall are expected to grow in the fourth quarter, with the metals and phosphate fertilizer markets registering the strongest volume growth.

Now let me wrap up on the next slide. Looking ahead and as I mentioned earlier, discussions with our customers and key economic indicators point to continued growth in the majority of the markets we serve throughout 2011 and beyond. With that as a backdrop, CSX's fourth-quarter outlook remains favorable. Although economic growth is moderated, growth is expected across most markets. Intermodal, metals, and fertilizer markets are expected to lead the growth, while strong export volumes are expected to continue to partially offset the challenges in the domestic utility coal market.

Looking at 2012, early indications point to modest growth as a foundation. In addition, strong Intermodal growth is expected due to modal conversions and the onboarding of new customers. Agriculture and fertilizer markets are expected to rebound.

Finally, export coal demand is expected to remain strong, although utility coal will remain challenged by low gas prices and new regulations.

In closing, CSX will continue to create compelling value for our customers as they seek transportation providers that deliver solutions that are safe, efficient, and environmentally friendly. Thank you and now let me turn the presentation over to David to review our operating results.

Thank you, Clarence, and good morning, everyone. Over the past several quarters we have talked about CSX employees being mutually accountable to each other for achieving superior results in safety, productivity, reliability, and customer service.

Looking at safety, CSX once again delivered strong performance reflecting the shared commitment of all employees. At the same time, CSX continued to strategically add employees and locomotives across critical lanes of the network. These resources further increase the reliability of operations and network fluidity. As a result, overall service improved sequentially again this quarter and key measures are returning to 2010 levels.

Our recent performance demonstrates that we are now providing a service product that meets our performance expectations and the expectations of our customers, and we expect this to continue.

Now let's review the results in more detail, starting with safety on slide 16. This slide shows third-quarter FRA, personal injury, and train accident rates over the last four years. The left chart shows personal injury results.

For the quarter, the personal injury rate increased slightly compared to the prior year coming in at 1.08. Also, we were deeply saddened by the loss of two employees. These tragic accidents underscore why safety is always CSX's first priority and a constant focus.

Looking at train accidents on the right side of the slide, the frequency rate proved 26% to 1.81, significantly better than previous years.

Now let's turn to the next slide and review operating performance. On the left side of the chart on-time originations were down versus 2010 and arrivals were also lower. On the right side of the chart, overall train velocity fell slightly and dwell increased modestly, both contributing to the decline in on-time performance.

While quarterly measures were below the levels of recent years, the network remains fluid and we continue to drive sequential service improvements. As such, we are optimistic about our progress, overall recovery, and long-term success.

As we move to the next slide, let me give you a more detailed view of the steady operational improvement achieved during the quarter. Over the last two quarters we have added locomotives and people to the network to ensure service returns to the levels our customers expect from CSX, and these resources are making a difference.

The charts on slide 18 show weekly on-time originations and arrivals during the third quarter as well as the first two weeks of the fourth quarter. As you can see, on-time performance has improved and recently reached levels consistent with full-year 2010 performance, as discussed earlier.

Originations reached 80% during week 39, while arrivals climbed to 69% in the same week. This performance has also been sustained into the first two weeks of the fourth quarter.

Let me call your attention to one piece of data that really is a testament to the exceptional efforts of CSX employees. Networkwide on-time performance was not significantly impacted by Hurricane Irene or Tropical Storm Lee. I believe that with such commitment to serving customers safely and reliably we will continue to improve service.

Turning to the next slide, let's look at velocity and dwell. Consistent with on-time performance, network fluidity also improved.

While these measures did see impacts from Irene and Lee, as seen on the charts, they recovered quickly. On the left side, train velocity reached 21.1 miles per hour to end the quarter, while on the right side of the chart dwell fell below 2010 levels to 23.6 hours. Both measures have also remained strong during the first two weeks of the fourth quarter.

I am pleased to see these results, but there is certainly more work to be done to ensure this performance continues to improve. Now let's turn to the next slide and review resource levels.

While active T&E employees and locomotives have increased during the quarter, both remain well below 2008 levels, which as you recall was just prior to the economic downturn. As the chart on the left shows, CSX continues to hire additional train and engine employees in 2011 to both improve service and handle volume growth. It also highlights that despite these increases active T&E employees are still down 13% from 2008 levels with a corresponding decrease in volume of 7%.

Looking to the right side of the page, this chart highlights the sequential increase in locomotives by quarter. It also shows that despite these increases active locomotives also remain below 2008 levels. Going forward it is important to remember that CSX continues to have the flexibility to adjust both the hiring pipeline and manage locomotives to meet changes as service, volume, or attrition dictate.

Now let's wrap up on the next slide. Looking forward, CSX will build on its strong safety performance with a focus on continuous improvement in both personal injury and train accident rates. Service measures began to rebound late this quarter returning to 2010 levels. This performance demonstrates that we are providing a service product that meets the standard customers have come to expect from CSX, and we expect this will continue.

Additionally, resources are in place and flexibility remains to handle changes in attrition, peak volume, and growth. CSX employees are committed to providing the high levels of service customers expect, and in doing so, will deliver a strong foundation for their success and that of shareholders.

Now let me turn the presentation over to Oscar to review the financials.

Thank you, David. As we reflect on the record third-quarter results, CSX continues to achieve strong top-line growth and is following a disciplined approach to adding resources in support of customer service and growth.

Looking at the top of the slide, revenue improved 11% to nearly $3 billion on strong core pricing, modest volume growth, and the impact of higher fuel recovery, which was a slight tailwind in the quarter. These top-line gains increased operating income to $878 million.

Looking below the line, interest expense was up $7 million driven by higher average debt balances while other income was similar to last year. In addition, income taxes were $282 million for the quarter for an effective tax rate of 37.8%. Finally, EPS was $0.43, an improvement of 19%.

Turning to the next slide, let's discuss expenses in more detail. Total expense was up 13% versus last year's third quarter driven primarily by the impact of higher fuel. Excluding fuel, total expense was up 7%.

Now I will talk about the top three expense line items in more detail on the next few charts, but let me briefly speak to the last two expense items on this slide. Depreciation was up 8% to $251 million, primarily due to the increase in the net asset base. This is in line with our previous estimate and should continue to increase slightly on a sequential basis.

Equipment rents were up 6% to $95 million with increased volume in merchandise being the primary driver.

Turning to slide 25, labor and fringe expense increased 5% or $34 million from last year. The impact of wage and healthcare inflation in this quarter was $29 million or about 4%. You can expect this level of inflation to continue in the fourth quarter.

Now turning to the chart on the left, as we projected headcount this quarter was up 4%. Now if you break down this increase, slightly more than half of the employees and associated wages are included in operating expense. As David mentioned earlier, these are the employees working to support improving levels of customer service and the employees currently in training to help offset attrition to meet peak demand levels.

The other half of the employee increase is for field engineering forces for both positive train control and ongoing capital projects. The majority of the employees in this group are capitalized and, therefore, have little impact to operating expense.

Reflecting the investment we have made to enhance reliability, service- and training-related cost was $27 million in the quarter. In addition, CSX recognized $14 million of non-recurring payments in the quarter related to a facility closure. Partially offsetting these items was $30 million of lower incentive compensation. If you look to the fourth quarter, you can expect incentive comp to continue to be favorable, although at a slightly lower level.

Finally, there was a favorable net $6 million of other items which we do not expect to repeat.

Turning to slide 26. MS&O expense increased 10% or $53 million versus last year. Looking at the table to the right, inflation was $11 million of that. Volume-related expenses increased $16 million in the quarter. While overall volume was up just 1%, as Clarence noted, the volume-related expenses here reflect our growing export coal and domestic intermodal business segments.

Resource-related costs, which include higher maintenance due to an increase in the active locomotive fleet and increased crew travel expenses, were up $6 million. Other costs increased by $20 million this quarter and reflects the cycling of prior-year items, higher property tax expense, and the cost impact of Hurricane Irene and Tropical Storm Lee.

Looking forward, the third-quarter MS&O expense is a good starting point for Q4 as the export coal and domestic intermodal costs we have seen increase this year will continue with strong outlooks in both of those markets. We will also see an uptick in a few other seasonal cost items in the quarter.

Finally, keep in mind for the fourth quarter of last year we had a $40 million favorable casualty reserve adjustment which is not expected to recur this year.

Now let me wrap up the expense discussion on slide 27. Total fuel cost increased 48% or $133 million versus last year. Looking at the chart on the left, CSX's average cost per gallon for locomotive fuel climbed to $3.13, an increase of 44%. This increase in fuel price accounted for $117 million of higher expense, as seen in the table on the right.

Next, slightly lower fuel efficiency and volume accounted for $7 million of incremental expense. And rounding out the table, non-locomotive fuel increased by an additional $9 million.

While CSX has an effective fuel recovery program, higher fuel costs are recovered with an operating ratio of approximately 100%. As such, the operating ratio impact of higher fuel versus last year was 110 basis points in this third quarter.

That concludes the financial review for the quarter. Now I will turn to a discussion of our cash deployment strategy and long-term guidance.

On slide 28, if you look at the chart on the left, we have collectively repurchased $7.2 billion of shares since the beginning of 2006. In the third quarter of 2011 our total cash deployed for share repurchase was just over $1 billion. Including the shares repurchased last quarter, we have now completed $1.3 billion of our current $2 billion share repurchase program. The remaining $700 million of repurchases under the current program will be completed by the end of 2012 and will be funded primarily through free cash flow.

As a reminder, once the current program is complete we anticipate continued share repurchases of approximately $1 billion a year from 2013 through 2015. Again, funded primarily through free cash.

Share repurchases, as you know, are just one element of our balanced approach to cash deployment, and as we have discussed earlier this year, capital investment is expected to average 18% of revenue over the five-year period between 2011 and 2015. Finally, CSX is committed to a dividend payout range of 30% to 35% of trailing 12-month earnings and this will be reviewed annually every May.

Now with that as a backdrop, let's review CSX's long-term financial targets.

CSX continues to deliver strong results that create value for shareowners and we remain confident in the long-term guidance we presented earlier this year. The building block of the guidance we presented is a stated goal to grow to a 65% operating ratio no later than 2015. Core pricing above inflation, long-term productivity focus, and volume growth above the economy are the key drivers to help attain this target.

Compound annual growth rates and operating income of 12% to 14% and an earnings per share of 18% to 20% are the result of the confidence in our ability to execute on these drivers and represent a significant growth off of a strong 2010 base.

Now before I turn the presentation back to Michael, let me remind everyone that last year's fourth quarter benefited from the additional volume and revenue associated with the 53rd fiscal week, which does not occur in this year's fourth quarter. So with that let me turn the presentation back to Michael.

Thank you, Oscar. When we step back and look broadly at the third quarter we see two important attributes. First is a persistent commitment to customer service throughout our workforce. We were pleased with the progress in the third quarter and remain committed to providing excellent service to our customers, both now and in the future.

The second is our track record and ability to deliver strong financial results across an array of economic conditions. That will continue. Our business is working as it should, delivering strong results, investing back into the business, and hiring thousands of employees in excellent union and management jobs.

Negotiations with the three bargaining groups representing railroad employees began in January of 2010 and in the third quarter of this year the industry was pleased to reach an agreement with the United Transportation Union, which is the largest. That industry agreement maintains a considerable compensation premium compared to other industries, and includes very competitive benefits package for our employees.

As you probably know, agreements with the remaining unions have not been reached, and as part of the prescribed process, a presidential emergency board has been established to offer recommendations for a settlement. The railroads believe we have competitive offers on the table and that settlements can be reached. In the meantime, the Company and its employees are working cooperatively as expected.

It is important to note that during the last 20 years there have been only two days of strike activity at the major freight railroads. Railroad employees are exceptional, proud people who come to work every day knowing that what they do is essential to the economy. They also recognize that we continue to offer some of the best jobs available in America. We look forward to continuing to work together with them to achieve great results for our customers and our shareholders, and on their behalf I would like to thank you again for joining us this morning.

With that we look forward to answering any questions you may have.

(Operator Instructions) Scott Group, Wolfe Trahan.

Thanks. Good morning, guys. So, Clarence, wanted to follow-up on your comments on utility coal for 2012. If we assume kind of normal weather and continued low gas prices, are you expecting similar kinds of volume declines next year, or into easy comps do you think utility coal can be more flattish or up slightly? I just want to understand your commentary.

Thanks, Scott. What we are seeing happen in the utility area for us in our areas that we serve is that the stockpiles in the north are near normal. The stockpiles in the South, even though they are down, are slightly above what the normal target range could be.

Gas prices, as you know, this morning we are at $3.50. They are staying low; we see no reason for that not to remain low. We think we have seen all the impacts from CASPR, but possibly a little downside coming in the next -- in 2012. So we expect for them to be either about where they are or slightly down.

Thanks, that is good color. And then one for Oscar. So based on Clarence's expectations for modest volume growth next year, do you have any preliminary thoughts on where headcount should be up next year? And just generally, do you think it's tough to see margin improvement in the near term before this big spread between volume growth and headcount flattens out?

Scott, yes, we will continue to hire to offset attrition and meet our peak demand. The levels of that headcount have not yet been determined. And with regards to improving margins, yes, that is actually very much part of our Grow to 65% initiative, and we do have all those plans in place.

But I guess in the near --

Go ahead, one more.

I guess in the near term, Oscar -- we have got 5% headcount growth or 4% headcount growth and flattish volumes, is that a -- can you improve margins in that kind of scenario? Or do we need to wait a couple quarters before that spread flattens out before margins can start improving again?

Well, I think we will see margins improve. The volume aspect of the projections that we have over the next few quarters help in that regard.

We do see modest growth.

And we do see modest growth, right.

So starting in fourth quarter again you think?

Yes, Scott, we will see improvement in our operating margins in the fourth quarter.

Great, thank you.

Ken Hoexter, Merrill Lynch.

Good morning. Now if I could jump back to Dave for a second, it seemed like the service levels kind of bottomed out before the storms. Just wondering what structurally occurred to bring the service levels down to such a low level, and then what you shifted to get it back on track following the storms to get these on-time performance levels back up.

Sure, Ken. We did experience early on in the year, which we talk about in prior quarters, as you know issues that impacted our overall service levels. We outlined after the second quarter our plan to, in a very deliberate way, continue to make improvement throughout the third quarter.

We were on that track and we were accomplishing that. We were set back somewhat by the storms that occurred, Irene and Lee, but very temporary setbacks and sort of marginal declines in service during those periods that were recovered quickly. And now we are right where we wanted to be at the end of the third quarter as we go into the fourth quarter.

We added some resources, we have improved our headcount somewhat in our T&E ranks, and also as well brought on some locomotives. As we said, we were going to bring on a total of 250 additional and we are in the process of doing that. So all those are factors and we felt very confident as we go into the fourth quarter about continuing that improvement.

Okay. And then, Oscar, just to clarify that last remark. If you talk about the operating margin or operating ratio, you had talked about it not reaching your 70% target for the quarter. And it seemed to be because of the volumes being weaker than anticipated.

Do you need those volumes, or am I hearing you that with some of these service and other things that you have put in place that is a bigger focus for getting that back on track?

I think it's a combination of both. Certainly that volume that we are projecting, that modest growth that we have talked about, is clearly part of that conversation. At the same time, obviously as you can imagine, we are very thoughtful in adding -- how we are adding this.

Now again, important we are talking about incremental margin here. So it's a combination of volume and continued cost management while investing for the service that we want to have for our customers.

All right. Thanks for the time.

Tom Wadewitz, JPMC.

Good morning. Wanted to ask a question around export coal. I think that you were -- Clarence, you gave some comments on 2012 export coal that you expect it to be strong. How much visibility do you think you really have on that looking forward? And I guess within that strong view does that assume that Australia comes back in a pretty meaningful way in terms of volume?

It just seems like that is a market that is particularly difficult to have visibility and convictions, so want to know what is behind your commentary there.

Thank you, Tom. First, I do agree with you that this is a difficult market to have convictions in because of the volatility in it. But Australia is back in terms of their production, but they are still facing the rainy season that is going to occur between December and February, so that is Mother Nature's call as to what happens there.

Number two is that if you look at what the forecast is for global steel production over the next eight years it's estimated to be up 60%, primarily driven by East Asia, Southeast Asia, and the Indian subcontinent. All of which we are exporting coal to and serving. Number three is that as we have talked to both our producers and to our receivers they are looking very robust for the export coal market going forward.

And I guess my final point would be to quote the Chairman of Peabody who said we were entering a global super cycle of coal. That is our fundamental belief based on that.

Okay. Perhaps one day we can ensure a super cycle for coal back in the US again, I don't know.

I would love that, Tom.

I would love it. I am pulling for it.

It would be good public policy.

Indeed, indeed. On a different topic, you were pretty aggressive in buying back shares, which is a good thing to see you get opportunistic in third quarter. Your cash balance has come down a fair bit and I think that is something you refer to when you say how much you might buy looking forward.

What is the kind of minimum comfortable cash balance level that you would look at? Is it $200 million or $400 million? How would you look at that with respect to your willingness to be aggressive in share buyback in, say, fourth quarter?

The Company has strong cash generating power so the absolute balance is not something we sort of fix. But I think if you look back in history, we have kept roughly $0.5 billion on the balance sheet and that is probably what we would likely go forward with.

Okay, great. Thanks for the time.

Bill Green, Morgan Stanley.

Good morning. A quick just clarification, either Michael or Oscar. When we look at the commentary that you may just now on the buybacks and how much will likely occur in the next few years, it kind of suggests, given the current authorization, that you could see a deceleration in 2012. Are you willing to go back to the Board and ask for a re-up? Or is, no, it's really kind of $1 billion a year beyond; we just accelerated it this year so next year should see a deceleration?

Bill, I think we will just stick with what was said on the presentation. We expect to finish that $700 million by the end of 2012, primarily through the use of free cash.

Okay. And then on the -- when we look at the pricing for the rest of this year, one of the big drivers I think most of us assume has been export coal. And you have got a reacceleration implied by the guidance in the volumes there for the fourth quarter. So given the strength of pricing in that market is it realistic to think that pricing could accelerate here in the fourth quarter?

I think our guidance, Bill, if -- unless I am wrong here is it's going to exceed rail inflation and that is the plan.

Yes and it has been. And since it's a pretty important commodity for you I was just wondering if that means things can, in fact, get better from a pricing standpoint even in fourth versus third.

I think we would probably expect it to be similar on the export market. As you know, a lot of those have been contracted for the year so there is probably not big differences in the fourth quarter, Bill.

Okay, that is great. Thank you for the time.

Justin Yagerman, Deutsche Bank.

Good morning, guys. Want to try to pin you down a little bit harder on this export coal outlook; strong could mean a lot of things. This year was strong and a flat year could be construed as strong in the general context of how you guys look at this, especially if you are talking about an eight-year super cycle for steel. Is strong in your mind an up year next year for export coal?

I think in my mind, Justin, it's equal to or above.

Okay, so the outlook should be read as flat to up in terms of export coal for 2012?

Yes.

And, Justin, I think you are aware a lot of these metallurgical really is contracted on a fiscal April, so we are five to six months away from those being contracted. But, as Clarence said, based on mining investments being made in new mining capacity and our conversations with them, we feel pretty good about the export for next year.

Okay, good. On the intermodal side, you have the Maersk contract starting on Jan 1; would love to get some color on how we should expect to see that contract rolling on as the year progresses.

And then on the domestic side, curious to hear -- obviously that has been better than international this year for you guys, but you have been lagging behind your other eastern competitor. Maybe some thoughts on what you are going to be doing to attract a higher level of growth to the domestic side as you are -- you got a nice piece of business coming on on the international side.

Well, first, on the international side on the Maersk, we are very pleased that Maersk has awarded us that business and we intend to serve Maersk extremely well over the long-term period of that contract. As you are aware, we are not going to give out what the volume numbers of Maersk are because it's confidential information for Maersk.

But we expect to start on-boarding Maersk in the first of the year. Our operating department has a very extensive operating plan in place already about how they will on-board it. We have the crews, the locomotives, the cars already in place to be able to handle the volumes that is coming on, so we feel very positive about that.

In regard to the domestic growth, first, we think it's a positive thing when all railroads grow, so we congratulate Norfolk Southern's growth in their intermodal product. What is good for our neighbors is good for us. We, and ourselves, have been growing both our volume and our profitability on our top line. That is exactly what we intend to keep doing.

We are making sound financial investments in both new terminals, terminal expansions, and in our National Gateway project, so our intermodal strategy is on track to continue to grow. We have added new containers, both ourselves and the Union Pacific, the UMAX fleet. That fleet has been under great utilization here during both the third quarter and going into the fourth quarter. So I just think everything is very positive in it, Justin.

Sounds good, Clarence. In terms of the roll-on of that Maersk contract, is January going to be an even month in terms of how we think about those volumes coming on for the year, or is there a point in the year where all of a sudden the volume should start to ramp to a greater extent?

Well, obviously it starts coming on in January, but it will ramp very quickly.

But just normal seasonal pattern.

Normal seasonal patterns, yes.

Sure thing. Thanks, guys. Appreciated the time.

Gary Chase, Barclays Capital.

Good morning, everyone. A couple of quick ones. I wanted to see, Clarence, if you could give us a sense of where you think capacity on the export side would be in 2012. What is a reasonable upside boundary on what that volume might look like? You have obviously -- $12 million is a number you think is feasible this quarter. What might that look like next year?

Well, I think that previously we have said that our export capacity is in the neighborhood, the range of 45 million tons. We have plans on the drawing board that we could implement very quickly that could take that capacity up, and we have certain commercial triggers that we are going to look at along with our coal partners as when, where, and what time that we have to do that.

I think Michael mentioned the point earlier that was very important. We have three announced mine openings on our territory by companies that have made public announcements that they are committed to the metallurgical and the export market. And that is another reason why we feel very positive about having growth in our export business next year.

Okay, so 45 million-plus --

In terms of capacity.

Right, right. For David, just wondering -- again looking at back to a question somebody asked earlier about the contrast between the weeks before the storm and the weeks after. There, at least as we read it, was a pretty significant change in the volume dynamic as well. Wondering if you feel as though you missed volume in some of those periods; if we should be thinking that with the operations back at the levels that they are currently at, we should expect a stronger volume dynamic regardless of sort of the macro picture.

Gary, there might be just a little bit as a result but really we are currently at our volumes today, very current in terms of volumes that are on the network. We know that we are going to continue the improvements we talked about and that we will be prepared for any incremental changes that come in terms of volume.

Okay. Thanks, guys.

Chris Wetherbee, Citigroup.

Thank you for taking the call. Maybe if I get a little bit of your outlook for the remainder of peak season. And then for the fourth quarter, specifically on the grain market, we have seen some weakness here; kind of curious your thoughts about how that should look as we move into the fourth quarter, whether there has been some timing issues there.

Chris, this is Clarence. Good morning. On the peak season, as you are aware, we are in the peak season. Volumes are up. I wouldn't say that peak season is the true peak that you and I have traditionally seen; it remains to be a bump.

Container capacity on the West Coast has been very tight for the last three weeks, but it's not to the level that it was in a couple of earlier years where there were severe box shortages. But peak is -- it's nothing to write home to mom about, it's just a bump.

The ag business has been very interesting this year. As you know, the crops got into the ground late. They are running about two to three weeks late coming out. It's still going to be the third-largest crop, according to the USDA, that we have had on record. The yield per acre is down to 147 bushels per acre, which is the lowest in the last 10 years, so it's still going to be a tough season here in grain.

Corn prices have stayed up. Exports, both in soybeans and in corn, won't be at the levels that they were in previous years. We think that forebodes well for our phosphate fertilizer business because in order to get those yields up and to get those crop improvements up we are going to have to fertilize, apply nitrogen units to the fields. So that is going to be a very positive thing for us, both in the fourth quarter and in 2012.

Okay. From the pure grain business, it looks like it maybe is a little bit more of a push as opposed to the strength you are seeing on the fertilizer side.

That is right.

Okay, fair enough. Then maybe if you have any other kind of comments about whether -- I know you kind of talked about right after the storms that you maybe saw $10 million to $15 million of impact there. Just kind of curious if there was anything further to that that kind of came right after some of those big storms that rolled up the East Coast. Just trying to get a sense if there was any other impacts on the quarter.

This is Oscar; David can jump in on the actual operational impacts. We did see a little bit here and there, but again our team has recovered greatly. Lee actually was a bigger impact to some degree with the flooding that was -- the residue after that. But again we said $10 million to $15 million; probably coming in an overall of $10 million, both between revenue loss and expense items.

Okay, great. Thanks for the time, guys. I appreciate it.

Chris Ceraso, Credit Suisse.

Good morning. It's Allison Landry in for Chris. I was wondering on the utility coal side if you could talk a little bit about some of the natural gas switching capacity that is left on the network. Is there a lot further room for the utilities that you serve to switch?

Allison, this is Clarence. There is always some room, but most of the switches that could possibly have been made were already made on the economics of dispatch when gas got so low. The older, coal-fired plants were idled, so we don't expect to see much impact on that at all.

Okay. And then for a follow-up, on the export side did you see any of the volume delays because of some of the repair and maintenance at the port facilities in the quarter? And will any of that be made up in Q4?

There was some activity around one particular port, but the bigger impact for the third quarter was the miner's holiday and vacation, which you know occurs every year and happens. Now having said that, we expect the run rate in our fourth quarter will be what it was pretty much in our first and second quarters.

Okay, so you would expect a sequential uptick then?

Absolutely. Last year we had a 24% sequential uptick between the third and the fourth quarter, and we expect to have a very robust one this quarter.

Okay. Thank you for the time.

David Vernon, Bernstein.

Morning. Just a quick question on the intermodal business. I had seen somewhere in an article that that was going to be routed up through Baltimore on a single-stack service. Is that the case? And if that is so, how long do you think it will be kind of running single-stack versus double-stack?

David, this is Clarence. That is the business obviously, the Maersk, you are referring to coming out of A.P. Moller terminal in Portsmouth. It will be routed up through Baltimore; it will be single-stack.

Our operating people have the clearances going on now in the National Gateway, and our law and public affairs people are working on the Virginia Avenue Tunnel to get it cleared in Washington, DC. So I think the timeframe is -- for that tunnel is probably in the two to three year or longer range. That answer your question?

Yes, it does. Thank you very much. Then just as a follow-up maybe could -- Michael, could you maybe talk a little bit about the 65% OR target and whether or not that is already kind of working its way into the management incentive programs? And then how that kind of gels with the reduction in the incentive accruals?

Clearly, we feel very good about our 65% operating ratio no later than 2015. Obviously, the Board sets up our compensation schemes to match those public targets, so in our longer term incentive plans they are geared toward making and exceeding those targets.

On the incentive compensation changes you saw this quarter, obviously a little bit of the softness we saw here in the third quarter in volumes is impacting our agile incentive. So obviously we very much -- the Board very much ties our rewards to the performance for our shareholders, and with the earnings slowing down just a bit here in this quarter, obviously the compensation is going to be lower for the management team.

All right, great. Thank you.

John Larkin, Stifel Nicolaus.

Good morning. Thanks for taking my call. Could you give us a little more color on why the other unions, aside from the UTU, were unwilling to sort of go with the template that was included in the UTU agreement? Was at work rule related, base pay, benefits; what were the sticking points?

It really was not work rule related. It was more dealing with the absolute level of wage increases, as well as some adjustments that we are seeking on the health and welfare side with some co-pays.

I think their view is that they think we should be sharing more of the profitability we have seen. We are making clear to them we need that monies to reinvest in the infrastructure. And I guess, with all due respect, a 17% raise and health and welfare twice as good as federal workers, to me it's a little bit difficult to believe we won't be able to reach agreements with them.

As you know, we have the presidential emergency board in place, which is doing its work now and will make a recommendation early in November, probably the sixth or seventh of November. Hopefully that five-member panel will look at what we have offered the UTU, which we think was a very generous package, and compare that to what they are asking for and be able to show something that both parties can live with.

Thank you. And then just one quick one on the NIT League's proposal for reciprocal switching, which I believe is sitting down at the STB. How do you think that is going to play out here over the next month or so?

Well, it's a little hard to tell what actions the STB might take, but I think they are very cognizant of our need to earn adequate monies to be able to continue to invest in the infrastructure.

I guess when we look at that proposal, John, to us it just looks like an open access recommendation that wrongly tries to tie a replacement of a public interest standard, investing in the infrastructure, with formulas. And it's, in our view, a clear attempt to change the rules to gain an unfair advantage.

It's really nothing new. As with the other open access proposals, there is no reliable evidence to support this, no mention of the impact on rail operations or infrastructure investment. So we really ultimately believe any final resolution beyond the scope of the (inaudible), which actually come from Congress not from the STB.

Thanks for the good answers.

Ben Hartford, Baird.

Morning, thanks for taking my call. I think this is directed to David.

David, I just wanted to get your sense on productivity. Good job getting service metrics largely back to the 2010 levels, but in terms of employee productivity, if you look at revenues per ton mile -- revenue ton miles per employee, gross ton miles per employee, we are still below 2010 levels and below peak levels effectively.

So I am interested in your perspective in terms of what is going to get productivity back to 2010 levels and back to peak levels; whether it is volume alone, whether it will be largely on the headcount side? Can you talk a little bit about that?

Sure, Ben. We have actually seen -- and we look at productivity in terms of employees per gross ton miles differentiated between our T&E employees and our overall employees. So while you see overall has come down slightly, our T&E productivity is at an all-time high. Remains at all-time high levels.

So it really has to do with some hiring we are doing now to begin implementation of PTC, the things Oscar talks about in terms of our incremental headcount other than our T&E headcount.

So we do have initiatives as we go into the coming years and around productivity. We have had a strong performance in the past in productivity and we believe in the future we will continue to accomplish that. Understanding that we have brought on some additional costs that will continue into the future because we are putting service reliability at a very high priority.

Okay. Then as a follow-up, Clarence, could you talk a little bit about the pricing dynamics on the domestic intermodal side, given freight demand has moderated here, truckload pricing is still positive but decelerating? Can you talk a little bit about your outlook here in the fourth quarter into 2012, given your assumption that, I think rightfully, so that the conversion on the truckload side, that opportunity will continue?

Ben, as you know, we price to the market dynamics, and right now our pricing is actually up in the last few weeks because as I mentioned, the demand coming off the West Coast is strong. Container supply on the West Coast has been extremely tight for the last two or three weeks. So in pricing that market, we've taken those rates up.

Now January is going to be a different dynamic. It is January, business drops down. We will price accordingly what our competition what the market is as that occurs. Then as the early weeks around March and all start to pick back up in economic activity, our rates will again start to move up. So they go in sort of cycles, if you will, based on what the demand is.

But longer term, the CSA 2010 highway congestion fuel prices are going to give us some good strength in that --.

Absolutely, and is in fact doing it.

Thanks.

Jason Seidl, Dahlman Rose.

Good morning, guys. One quick question on headcount. Can you give us a sense as when the hiring is going to start to level out beyond the normal attrition rate, so we can sort of forecast maybe more normalized productivity for the people that come into the training and then are put to work on the railroad?

We do model our forward hiring based on attrition, primarily with any additional hiring in terms of headcount based on any volumes or traffic flow changes that we see occur. Because we do hire locally and we have many, many centers or population centers for our employees. So we really have not changed our hiring strategy from prior years into this year, other than forward hiring a little bit for some volumes we see coming in next year. So in terms of the numbers, the absolute numbers, it is almost entirely based on our attrition rates that we see continuing in the future.

So just to follow up on that, the forward hires for some of the anticipated volume next year, whether it be the numerous traffic or other business, have already been completed now and those people sort of are in training now to be put to work next year.

Yes, that is right.

That is all I have, guys. I appreciate the time.

Matt Troy, Susquehanna.

Good morning, two questions. I guess first on export coal, we obviously saw some misperception in the market a couple of weeks ago surrounding some pre-announcements by some of the coal guys on exports. I was just wondering if you could put some context; I don't think the market quite understands the profitability of your export coal or that some out there might be grossly exaggerating its profit contribution.

Could you just maybe broadly put some context around export coal profitability relative to both your normal coal, domestic coal business, as well as the broader growth?

Yes, this is Michael. Let me address that one, Matt. As we look at -- we love our coal business, we love our export coal business, and we love our utility coal business. But I think you are right, there was a misperception out there in the marketplace that somehow that export coal was extraordinarily profitable versus our regular utility business.

Both of them are profitable and fairly similar in their profitability. So we love both of them, but there is not an extraordinary profitability to the export coal.

Okay. Secondarily, just on the domestic front, you seem to strike a more cautious tone than your competitor, Norfolk Southern, particularly around utility demand into next year. And also I think expressing to get ahead of some of the issues that might impact your business from a regulatory perspective.

Could you just perhaps talk to those, what those issues might be? And from your triage or analysis what percentage of your book of business might be vulnerable, and what is accounting for the share under performance on a more near-term basis? Thanks.

Matt, this is Clarence. First, our utilities -- and please, I don't mean this smart-aleckly -- our utilities are not Norfolk Southern's utilities. They operate in different areas, they are in different plants. Some are baseload, some are intermediate, and there is a difference in how those two things operate. So that accounts for one thing.

Number two is it will vary by utility to utility as to what their gas burns are. Some utilities, for example, will have forced burns in their coal contracts and that has some influence on it. A third thing I guess you were addressing, which was the CASPR. We think we have seen most of the impacts already from that, both as a result of older plants being idle and as a result of natural gas displacing the more inefficient plants.

So we expect to see some slight downside next year, as I mentioned earlier, as a result of CASPR and as a result of some of the utility stockpiles, but that is about the extent of it.

So it's -- just to be clear, it's reflected in the numbers today? There is not like some incremental drop off on the comma as a result of CASPR or gas?

That is right. You are correct.

Thank you for the details.

Walter Spracklin, RBC Capital Markets.

Good morning, guys. Thanks very much for taking my call.

I just wanted to play devil's advocate just for a moment here and just sort of clarify for me how I am interpreting this, because initially you had given us a headcount guidance of 3% for the year. You then increased that to 4%, and by my numbers, it looks like it's coming in well over 5%, maybe closer to 6%.

You have indicated that that is going to serve growth and service. And then when I look at your slide deck on page six, I mean those are the same slides that economists and everybody else are looking at but are really drawing the opposite conclusions of kind of an expanding economy. And I think looking at that slide I see inventories coming up quite significantly and the ISM Purchasing Managers Index coming down to -- almost reaching through that contraction line.

So looking at that and then looking at the third-quarter performance, yes, you have got two weeks of positive performance, but we know that is not a trend. And I guess if you could take the growth that you are talking about in your employee headcount and sort of guide us more directly as to is this really going to service a growth component that you are looking for, or is this more to address the service component that you are pointing to on slide 17?

Well, Walter, you certainly are being the devil's advocate here. I will give you credit for that.

As we look at it, obviously the economy has moderated here some. We talk to our customers -- and I know you wanted to mention the indices. They still are positive, although less so, but our customers are really indicating they see modest growth in the coming porters. And we think in most of our major markets that is what we are going to see.

As we talked about, we do have the Maersk business coming on January 1. So if I think about the headcount we are bringing on, it's really some to maintain those high levels of service that supports our growth initiatives as well as our pricing initiatives and some of it is for just the natural attrition. So it's really for both, for the service and for the growth that we anticipate.

And we do think that in 2012 we are going to continue to see modest growth going forward and we want to be prepared to handle that growth.

Okay, and I appreciate your candid nature there. It is question we are going to get, so I just wanted to put it to you as well. Second question --

Walter, if I could interrupt your just a second. Your starting point was you saw out a 5% or 6% increase at some point in time. And our year-to-date increases is as we have stated and we are going to, on a full-year basis, do it about 4%. So you may want to check in later to see what our math is, but that is our projection.

Okay. Well, we are probably looking at average -- I was looking at end of period and then -- but yes, we could certainly double-check on that after the call.

Second question here is on your inflation. You have actually quantified for us -- that is the first time we have seen that, thank you for very much -- the 4.2% is what you consider to be rail inflation. Is that a number that is representative in your view of a longer-term number, or is there something in the next 12 months that would cause that 4.2% to be an abnormally high number and perhaps the real kind of expected long-term inflation would be somewhat below the 4.2%?

Actually, Walter, that is a great question. It has recently been modified.

Global Insight.

Global Insight is the folks that calculate that work and I think the latest one came in around 3.5%, so that already has dropped a bit.

Okay, that answered my question. Thank you very much, guys.

Jeff Kauffman, Sterne, Agee.

Good morning. Thanks for taking my question, guys, and solid quarter in a very challenging environment.

Oscar, a question for you. Once we get past this investment phase and once we get to a more normal static kind of growth world what do you believe the incremental margin the railroad should be making on the incremental dollar is?

Well, clearly probably (multiple speakers).

Not 18%, right?

Probably -- clearly the run rates we had in the first of this year would be the things we would focus on. Again, as we grow to 65% the math is inherent in that that you are going to have to see those 50%, 60%-plus incremental margins.

How long do you think it takes us to get back toward that run rate? Are we looking kind of at a year-end 2012, 2013 just because of some of these issues with the utility stockpiles and investment that you are talking about?

Clearly volume is a -- productivity and price get us a long way there, but volume is an inherent part of that Grow to 65% initiative. And so as far as the timing, your guess is as good as ours. We have a good vantage point, we see the modest growth into 2012 that Clarence outlined, but beyond that it's hard for me to tell you exactly when that is going to --

Well, to that point, on the incremental growth I mean, David, you have, what, 10% to 15% capacity on your merchandise trains and 15% to 20% on the Intermodal? So clearly, Jeff, as we bring those volumes on there is very good incrementality of those, so we think the modest growth we are expecting will help fill those trains out.

Okay, thank you very much and congratulations.

Anthony Gallo, Wells Fargo.

Good morning. Thank you. Want to just briefly go back to the export coal. What is the end market mix this year and how do you expect that to change in 2012? And do you expect a change between met and steam coal?

Met is 65%, thermal is 35%. As Michael said, it's six months away from the metallurgical contracts being renewed, so it's a little bit too early for us to tell if that mix will change at all in 2012.

How about the end markets? You have mentioned Europe, Asia, South America. What is that today and do you expect that to change much in 2012?

Not in 2012.

Basically, what, it's about 50% sent to Europe, 30% into South America, and about 20% into Asia.

That is right.

Okay. And then, I am sorry, I just want to make sure I understand the pricing in the export business. You mentioned met coal contracts are annual. Is pricing quarterly or just could you remind us export pricing, how often that is?

Well, you two types of pricing in that export -- three types actually. You got the tariff pricing, then you have annual contracts usually run from April 1 of a year till March 31, and then you have the spot market contracts, which is what you were alluding to with the quarterly pricing that goes in, as well as the adjustment in the tariff on a quarterly basis.

But only about 10% of the business moves on tariff, right?

That is correct.

Okay. And how much on spot?

I don't know off the top of my head. More moves under contract than moves under spot.

Okay, great. I will keep it to those questions. Thank you, gentlemen.

Peter Nesvold, Jefferies.

Morning. Just one very quick one here at the end. Any early expectations for CapEx on rolling stock for 2012, and how would that kind of split between locomotives and rail cars?

It's Oscar, Peter. No change to our broad long-term guidance, but no specificity on 2012 yet. We are still working through those plans, but certainly locomotives and cars are a big part of that plan.

Okay, great. Thank you.

Thank you all for joining us today. See you next quarter.

This concludes today's teleconference. Thank you for your participation in today's call. You may disconnect your lines.