Genesee & Wyoming Inc. Q3 2008 Earnings Call Transcript

Genesee & Wyoming Inc. (GWR)

Q3 2008 Earnings Call

November 3, 2008 11:00 am ET

Executives

Matthew Walsh – Senior VP, Corporate Development and Treasurer

John C. Hellmann – Chief Executive Officer, President

Timothy Gallagher – Chief Financial Officer

Analysts

Jason Seidl – Dahlman Rose & Co.

Edward Wolfe – Wolfe Research

Christian Wetherbee – Merrill Lynch

Arthur Hatfield – Morgan, Keegan & Company, Inc.

Thomas Albrecht – Stephens Inc.

Presentation

Operator

(Operator Instructions) I would now like to turn the conference over to our host, Mr. Matt Walsh.

Matthew Walsh

Thank you for joining us today on Genesee Wyoming’s Q3 2008 earnings call. We will start with the Safe Harbor statement and then proceed with the call. Some of the statements we will make during this call, which represent our expectations or beliefs concerning future events are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934.

To provide the Safe Harbor for such statements, our use of words such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks and uncertainties and other factors that could cause actual results to differ materially from our current expectations. Including but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission.

Please refer to our filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake any obligation to update this information and you should recognize that this information is only accurate as of today’s date.

Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are posted under the investors tab of our web site, www.gwrr.com with the events details for today’s earnings conference call.

On the call today we have two speakers, our President and CEO Jack Hellmann and our CFO T.J. Gallagher. I will now turn the call over to our President and CEO Jack Hellmann.

John C. Hellmann

Welcome to G&W’s third quarter earnings call. As always, I’d like to start our call this morning with safety which is a good indicator of how well we are running out railroads.

For the first nine months of 2008 our injury frequency was 1.3 reportable incidents per 200,000 man-hours, which is 24% better than the same period of 2007 and ahead of our 2008 target of 1.5. Through September four of our nine regions have not had an FRA reportable injury which is consistent with our ultimate goal to be an injury free company.

Now turning to our financials. Our third quarter results were strong with earnings per share from continuing operations of $0.55 which was ahead of our expectations. Total revenue increased approximately 22%, same railroad revenue increased around 12% and our operating ratio was around 78%.

The most significant feature of the third quarter was the balanced contribution from each of our nine operating regions. No single region was a standout but all contributed in a meaningful way. In those regions that had been more affected by the weak economy, such as Canada and Oregon, management has been very effective at controlling costs.

In those regions that have been less affected by the weak economy, such as Illinois, Rocky Mountain and Rail Link, results have been consistent with that stability. Meanwhile our acquisitions of KG, Maryland Midland, and Rotterdam Rail Feeding, continue to meet or exceed our expectations.

So when you add it all up, we reported operating income of $34.6 million which was the highest in G&W’s history. Excluding gains on asset sales, our third quarter operating income increased 38% over last year. In a moment T.J. will review our third quarter results in finer detail. However, I’d now like to share our perspective on five significant topics that we think are especially relevant in a time of unprecedented economic turmoil.

The first topic is the relative stability of G&W’s business. Like most railroads, a significant portion of our total revenue is not strongly correlated with the economic cycle. Our own assessment is that approximately 60% of our total revenue falls into a category that we believe is less economically sensitive.

These less economically sensitive components include base load coal fire power plants, grain, salt for highway deicing, most of our industrial switching contracts and several highly efficient industrial plants that produce consistently in any economic climate.

Our two most recent acquisitions, the Ohio Central and Georgia Southwestern, are also good examples of revenues that are less sensitive to the economy. In Ohio we serve four solid waste landfills that ship garbage on a consistent basis, and we also handle significant online coal moves to a base load power plant. In Georgia our largest business concentration is in the peanut industry which typically benefits from recession since it is a relatively cheap source of protein.

Despite the general stability of our business, we believe approximately 40% of our total revenues have more direct exposure to the economic cycle. Amidst the current recession, we expect volumes in several shipment categories to remain weak or decline further. Throughout 2008 we have discussed the weakness in lumber enforced products, which is due to the weak US housing market, as well as the weakness in paper and newsprint. Trends that we expect to continue.

In addition, we see weakness in certain segments of the steel market as well as any traffic that relates to the production of automobiles. To a large degree for G&W these areas of weakness are being masked by the strong pricing environment as well as the ramp up of several new customers.

The second topic I’d like to discuss is the debt markets. Given the poor condition of global credit markets it is worth highlighting that G&W has immediate access to debt capital. In conjunction with closing the Ohio central acquisition on October 1, we also closed a new five-year senior bank facility that provides us with $170 million of immediate availability. You may recall that we secured bank commitments over the summer so our pricing and covenants are from that period versus the chaos in today’s credit markets.

The third topic I’d like to talk about is the successful two-year extension of the US short line tax credit. In a surprising turn of events the passage of the $700 billion rescue package for the US banking system, ultimately included the extension of the short line tax credit through 2009.

For G&W the short line tax credit is an important way to increase our resources for track investment in the United States, and because it lowers our tax rate we estimate that it will increase our book earnings in 2008 and 2009 by approximately $10 million per year.

Also, thanks to the removal of alternative minimum tax limitations that existed in the prior short line tax credit legislation, the more immediate cash benefit from the tax credit will now better match the timing of our track expenditures.

We are pleased with this outcome and are grateful to the many co-sponsors in the house and senate. Our objective now is to work with a strong bi-partisan leadership who supported the short line tax credit and make it a more permanent element of US infrastructure policy.

The fourth topic is our current philosophy with respect to acquisitions in a highly uncertain economic environment. G&W continues to be one of the few well-capitalized acquirers of rail assets worldwide. As a patient and disciplined acquirer, we anticipate good investment opportunities at attractive valuations to emerge. As we await the right opportunities, our attention is focused on successfully integrating the five acquisitions that we have now completed in 2008.

The fifth and final topic is to highlight that we continue to make long-term investments to support the expansion of our customer traffic despite a more capital constrained business climate. On railroads where we have slowing shipments we have taken active measures to increase free cash flow through reduced costs and tight management of capital expenditures and working capital.

At the same time, however, we are still investing for the long-term with several major customers. In South Australia we are investing approximately US $10 million to overhaul locomotives and purchase 28 new railcars to support the expansion of a major iron ore exporter under a take or pay rail service contract.

In the United States we are investing approximately $2 million for new siding capacity in western Pennsylvania to support new traffic being routed to us by a specialty steel producer.

In the Netherlands we are purchasing three new locomotives to further expand our services in the Port of Rotterdam. We believe these are excellent investments for our shareholders and will enhance our financial results into 2009.

I’d like to conclude my comments by repeating that thanks to the relative stability of our core business in a difficult economy and the quality of the railroads that we have recently acquired, we believe G&W is well positioned to weather the current economic storm.

With that, I’ll turn the call over to our CFO, T.J. Gallagher.

Timothy J. Gallagher

Earnings per share from continuing operations were $0.55 in the third quarter of 2008 compared with earnings per share of $0.60 in the third quarter of 2007. As we outlined in our press release, a number of significant factors impacted our results in the third quarter of 2007 including the short line tax credit, unusually large gains on asset sales, and a tax benefit associated with the ARG sale, all of which totaled $0.24 per share. Taking these items into account, our earnings increased significantly over last year.

Our operating revenues increased nearly 22% to $159 million as our acquisitions, strong pricing, fuel recovery and growth in non-trade revenues more than offset lower same railroad freight volumes. Excluding acquisitions, same railroad revenues increased over $15 million or 12% and of those $15 million increase non-freight revenues increased $9 million to 19% and freight revenues increased $6 million or nearly 8%.

The increase in same railroad freight revenues was primarily due to the continued strong weight environment and higher fuel surcharges. Recall that given the lag in fuel recovery, we received higher levels of fuel surcharge revenue in the third quarter linked to the higher levels of fuel expense incurred in the second quarter.

Combining the higher rates in fuel surcharges with a favorable shift in commodity mix, same railroad average revenues per carload increased 15.3% over last year. Also note that in addition to the higher fuel surcharges, falling fuel prices benefited us approximately $600,000 in the third quarter or about $0.01 per share versus our guidance in August.

Our 15.3% increase in average same railroad average revenues per carload was comprised of 9% in higher rates, 4.3% from higher fuel surcharges, plus an additional 2% due to mix. The impact of mix was primarily due to the loss of haulage traffic.

Excluding acquisitions, same railroad carloads decreased $13,700 or 6.7% due to the three factors we discussed previously. First, 50% of the shortfall or 7,000 carloads was due to the discontinuation of haulage traffic under Meridian & Bigbee Railroad. Note that this discontinuation took place in the third quarter of 2007 and so in future quarters we will no longer have this variant.

Second, same railroad farm and food product shipments declined 4,600 carloads primarily due to the depletion of South Australian grain stockpiles in July from the poor 2007 harvest. Please note that a new and expanded green haulage agreement is now in place in Australia and we expect a new harvest will begin shipping this week.

Third, our coal volumes declined 4,000 carloads or 8% due to the closure of a coalmine in Utah in March of 2008. The big picture is this, other than the highlighted haulage grain and coal I just discussed same railroad shipments increased by 2,000 carloads or by 1%. Our business performed well in a weakening environment.

Going forward, we remain cautious however about the impact of the current economy on the portion of our traffic that is most directly linked to economic output, such as lumber enforced products, [inaudible] paper, autos and certain portions of our steel traffic.

Now turning to non-freight revenue. Same railroad non-freight revenues increased $9 million or 19% in the third quarter. Continuing the same trends we have discussed all year, the drivers of this increase were $3 million in higher fuel sales, $1.5 million in higher recruiting revenue and $1 million in higher iron ore services all from Australia, as well as a $2 million increase in US industrial switching and port railroad revenues.

In the third quarter of 2008 we reported record operating income of $34.6 million compared with operating income of $29.7 million in 2007, an increase of almost 17%. Recall that in the third quarter of 2007 we had significant gains on asset sales including the sale of land for $4 million and a $1.5 million gain on the sale of scrap rail.

Excluding the gains on asset sales in the third quarters of ’07 and ’08 our operating income increased 38%. Our operating ratio was 78.3% in the third quarter of 2008 approximately 2.5 percentage points better than in 2007, excluding the impact of asset sales.

Now the discontinued operations. We reported income of $1.1 million or $0.3 per diluted share in the third quarter of 2008. Income from discontinued operations for the third quarter was primarily driven by an income tax benefit of $0.9 million resulting from tax deductions identified in conjunction with the filing of our US tax return.

Otherwise the results from our discontinued Mexican operations were essentially breakeven as minor balance sheet adjustments more than offset the administrative expenses incurred. We continue to be in active negotiations for the sale of our operations there.

Moving to free cash flow. Our continuing operations generated free cash flow of $58.5 million over the first nine months of 2008 compared with $69.6 million in free cash flow in the first nine months of 2007. The difference in free cash flow year-over-year is primarily related to working capital.

Net cash provided by operating activities included the sourcing of $11.6 million in working capital in the first nine months of 2008, while we sourced approximately $21.4 million in the first nine months of 2007.

Moving to guidance. Let me refer you to our earlier Safe Harbor statement that noted that these statements are subject to a variety of factors that could cause results to differ materially from our current expectations. These statements represent our expectations regarding future results as of today November 3, 2008 and we do not undertake any obligation to update this information.

Please note that our fourth quarter expectations are based on customer information provided late last week, current exchange rates, an average diesel price around $2.75 per gallon and our recent acquisitions. As always our fourth quarter revenues are seasonally weaker than in other quarters.

Before I get to specifics, let me start by highlighting current foreign exchange rates and the impact of the significant recent appreciation of the US dollar. Specifically affecting GVI the Australian and Canadian dollars have fallen over 25% and 15% respectively over the past few months. We expect the foreign currency and translation affect of these changes to reduce our total revenues from Australia and Canada by a combined $10 million on a quarterly basis, resulting in a reduction to our EPS of approximately $0.03 per share per quarter.

So, for the fourth quarter of 2008 we expect revenues of approximately $155 million and an operating ratio around 80%. These expectations represent growth of 15% on the top line and growth of over 40% in operating income compared with the fourth quarter 2007. We expect net interest expense to be approximately $8 million, and our effective tax rate to be around 27% excluding the retroactive portion of the short line tax credit. That is this projected tax rate reflects one-fourth of the full year benefit of the tax credit. Diluted shares are expected to be $36.2 million and D&A to be around $13 million.

The bottom line is that we are expecting fourth quarter earnings per share from continuing operations of around $0.45 to $0.48. We are tracking at the upper end of our guidance for 2008 at a $1.70 per share excluding the short line tax credit as our third quarter was a bit stronger than expected and our fourth quarter a bit lower.

So, with that I’ll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jason Seidl – Dahlman Rose & Co.

Jason Seidl – Dahlman Rose & Co.

T.J., in your guidance you’re assuming that the exchange rates stay where they’re currently at right?

Timothy J. Gallagher

Right, which is about $0.65 for the Australian dollar and $0.80 for the Canadian dollar.

Jason Seidl – Dahlman Rose & Co.

And when we’re looking out for the modeling where should we expect to see that hit on the specific line items the most, in terms of when you’re looking at your revenues from your operations?

Timothy J. Gallagher

Australia is more heavily non-freight while the Canadian is more heavily freight. It’s going to be more heavily, you know what it’s going to be about 50/50.

Jason Seidl – Dahlman Rose & Co.

Now are the Australian operations going to be impacted by the client and the diesel prices too?

Timothy J. Gallagher

Not as much because diesel is priced in US dollars worldwide and while diesel has come down the Australian dollar has fallen by in a similar fashion. So, their fuel costs in Australian dollars haven’t really changed that much. They’re a bit lower, not nearly as much of a drop as we’ve enjoyed in the US.

John C. Hellmann

So, Jason, in your model as T.J. said if you split it 50/50 between freight and non-freight, the two components of freight that are principally handled in Australia would be in minerals and stone which is [inaudible] traffic and the balance of it would be in grain and agricultural products, and then of course the other 50% is in non-freight and that included a whole host of things.

Jason Seidl – Dahlman Rose & Co.

Jack, could you talk about acquisitions, I don’t know if maybe I got the wrong vibe to your comments. You said you were going to remain focused on integrating the five companies that you acquired in 2008. We shouldn’t take that as your sort of being more cautious on the outlook for acquisitions should we?

John C. Hellmann

In an uncertain economic environment we’re going to just continue to be patient and disciplined as we always have, and we think good opportunities are going to emerge and we'll maintain that same discipline that we’ve always had.

Jason Seidl – Dahlman Rose & Co.

Jack, you saw a pretty big swing in your stock price here recently. Any thought to, at least enacting a share repurchase program to take advantages of near-term fluctuations?

John C. Hellman

Obviously there've been a lot of fluctuations in the stock right now and I would welcome anyone with guidance on the topic. However, our results are strong through a tough time, and let’s see how our stock stabilizes over time.

Operator

Our next question come from Edward Wolfe - Wolfe Research.

Edward Wolfe - Wolfe Research

An update on grain in Australia. I think you said in your comments that you’re going to start shipping grain next week. Can you give us a sense of how much, what the crops like and relative plans?

John C. Hellman

Sure, we expect the grain to be better than the past two years in South Australia, but weather in September was pretty dry, so it’s going to be another below average crop. So, it’ll be better than the past but not as good as a normal harvest. We will benefit. T.J. alluded to the fact that we have a new expanded contract.

We actually have expanded the resources that we’re deploying to our grain task beyond South Australia. We’re now actually going to be adding a new service in Victoria, the adjacent state to South Australia. So, we’ll benefit from that, we’ll benefit from higher volumes, but it will still be a below average harvest.

Edward Wolfe - Wolfe Research

Better than the last two years, but not better than '06?

John C. Hellman

'07, '08, sorry I’m getting old. I’m loosing track of years. Exactly right.

Edward Wolfe - Wolfe Research

The way to think of that in terms of carloads?

John C. Hellman

I would think about it in terms of revenues and these are rough numbers until the grains in the bin you can’t be certain. We’re initially projecting to be at least plus $5 million on grain revenues. That was the best information we have from down under. So, that’s how I think about it.

Edward Wolfe - Wolfe Research

That’s full year '09 over '08?

John C. Hellman

The wild card, Ed, is there’s also an addition to the grain that we export. There’s this interstate grain that moves for the feed business and the more developed states in Australia, and those patterns and how that grain moves is on a spot basis. In the past couple drought years we’ve been moving a lot of that. If we moved at similar levels of this past year we would do better than the $5 million that I indicated, but it’s very difficult to project those movements. It has to do with what other states are doing in the export market and how much grain is being channeled to them from other states. That’s why it’s conservative to think about that $5 million number.

Edward Wolfe - Wolfe Research

And that $5 million is net of currency?

John C. Hellman

No, that’ll be $5 million US dollar equivalent, but it’s not net of currency. I guess you could translate it, you can shave off another million dollars or so.

Edward Wolfe - Wolfe Research

Can we talk about, while we’re in Australia, what’s your sense of the worlds needs for commodities? You guys have a lot of iron ore and other things there is. Has there been a major slow down in that recently?

John C. Hellman

It depends. I think it’s safe to say that sort of the junior mining type projects that had previously been pretty aggressively expanding in Australia are by in large being put on hold, whereas the well financed big players that you know the names of still seem to be shipping at pretty good levels.

You’re hearing a few instances of take or pays by the purchasers not being honored by the sellers of the ores. From our rail perspective, our relationships in our take or pay arrangements are actually with the producers, of the miners, not with the end users and so we see what goes on in the overall markets that we’re actually economically neutral to it either way.

Edward Wolfe- Wolfe Research

What’s the visibility as you look at your yields and your pricing and I didn’t hear it if you said it, did you break down the yields between pricing, fuel and mix?

John C. Hellman

T.J. will review that for you because that’s a lot of numbers that were coming out pretty fast, so why don't we repeat those?

Timothy J. Gallagher

So on a same railroad basis, Ed, the increase over last year was 15.3%, and if you break that into rate, surcharge, and mix it’s 9% from rates, 4.3% of higher fuel surcharges, and then the last two is mix. The higher fuel surcharges of course, again, the spike in second quarter fuel prices passed into third quarter fuel surcharges.

Edward Wolfe - Wolfe Research

Is there a little currency in there as well?

Timothy J. Gallagher

A de minimis amount.

Edward Wolfe - Wolfe Research

What’s the visibility on that 9% rails as you get into the end of this year going into - -

Timothy J. Gallagher

Well, as I look at the fourth quarter, now in the fourth quarter our average revenues per carloads are going to be affected by the Canadian and Australian dollars, but if you just look at the U.S., I think we’re going to end up around 9% or so in the fourth quarter and that's all in. So, we’ll probably see less growth then we had in earlier this year, and that's principally due to the lower fuel price environment.

Edward Wolfe - Wolfe Research

But the pure pricing piece, fuel might be down year-over-year as a competent. Is the fuel pricing piece expected be less, I mean the pure pricing net of fuel?

Timothy J. Gallagher

It’s hard to breakout what I’m looking forward at this point.

Edward Wolfe- Wolfe Research

But what I’m trying to get is as you go into '09, what percentage of your business do you already have confidence in, is already signed or you’re in talks far enough that they have good visibility that they’re similar to what your seeing, and what percent we’ll have to see where '09 takes us?

Timothy J. Gallagher

Well, we have a number of contracts that roll annually and those price negotiations take place throughout the course of year. As that said, we feel pretty good about where our rates are heading into next year. But I can’t give you specific guidance about whether that’s going to be 7% or 10% or 5% at this point.

John C. Hellman

Some weighted average of what you’re hearing from the class ones will be where we end up. So, you’ll find us reasonably consistent with those numbers.

Edward Wolfe - Wolfe Research

Understood in terms of total and what we’re hearing from the class ones generally is between 50% and 70% of their book is already pretty solid for '09?

John C. Hellman

That’s right, that’s what they’re saying, and so our pricing outlook is still reasonably good, which helps mask some of this volume shortfall that we’re seeing.

Edward Wolfe - Wolfe Research

Again, it’s so easy to have kind of a nice tied up number maybe it’s not possible, but directionally when we think about how much the fuel surcharge lags, given your different businesses and given your businesses in Canada and in Australia as well. Is it generally two months we should use as a lag or how do we think about the lagging timing of the surcharge?

Timothy J. Gallagher

It’s actually for the portion of our revenues that are freight revenues that are interlined, which is 55%, 60% it’s to two months. For the rest of it, it’s going to be weighted average three to four months, so we have [inaudible] lined relationships that is close to six months. We’ve got other ones that are 12 months because they are indexed to our [inaudible]. You net it all together think three to four months is the right lag.

Edward Wolfe - Wolfe Research

The last questions I was surprised with your fourth quarter guidance at light to revenue fuels at 150 and I realized you said take 10 out for currency. Is there something else maybe non-freight revenue because there’s less fuel in there, what am I missing here? Are you not including the Ohio revenue?

Timothy J. Gallagher

If you had looked at my guidance from last August, there was an implied fourth quarter revenue in the uppers 160’s. You take off 10 for currency there’s going to be a lower fuel surcharge, and then we’re also again, we’re seeing some weakness in some areas that we weren’t seeing last August due to the steel which has rose considerably over the past few months and again, a little bit weaker paper and lumber.

Edward Wolfe - Wolfe Research

And what should we see from Ohio Central in here?

Timothy J. Gallagher

What you should see from Ohio Central is consistent with what we said when signed the deal, which is roughly $15 million or so of revenues.

Edward Wolfe - Wolfe Research

And that’s including the 150?

Timothy J. Gallagher

Yes, 155, and we included the Ohio Central acquisition in our guidance last August.

John C. Hellman

And I think what you’re missing sequentially is the fact that many of our contracts have volume thresholds that kick-in in the fourth quarter, so coal and some of the handling lines and you’ll see the pattern historically. You’ll see when you’re comparing quarter-over-quarter you’ll see the same trend in earnings continue, but when you’re looking fourth quarter always falls off.

Timothy J. Gallagher

Seasonality is typically about $5 million over third to fourth quarter.

Edward Wolfe - Wolfe Research

But, you do have the startup of the Ohio Central that’s what’s throwing me. So, you have the seasonality, but then you’re getting the extra $50 million.

Timothy J. Gallagher

Right, but that was in our guidance last August.

Edward Wolfe - Wolfe Research

Okay, understood. Thanks guys, appreciate it.

John C. Hellman

There’s nothing really out of the ordinary.

Operator

Our next question is from Christian Wetherbee - Merrill Lynch.

Christian Wetherbee – Merrill Lynch

I was wondering if I could just get a little clarification on the guidance. I might have missed it. I just want to understand, T.J., the EPS number that you mentioned the 45 to 48, just run me through the tax, the short line tax credit aspect of that. Is it the one quarter of the full year that you’re taking or does it not include any of that?

Timothy J. Gallagher

It includes one-fourth of the year.

Christian Wetherbee – Merrill Lynch

So that is a tax credit effective number?

Timothy J. Gallagher

We’ve talked all year before the tax credit was enacted having an effective tax rate around 38%. That’s the number I’ve used in each of our full year guidance, so the impact of the one-fourth of the tax cut takes us from 38% down to 27%.

Christian Wetherbee – Merrill Lynch

So that’s basically one quarter of the $10 million. Is that kind of how you’re looking at it?

Timothy J. Gallagher

Yes, and therefore it will give you a good apples-to-apples comparison with the fourth quarter of last year.

Christian Wetherbee – Merrill Lynch

Okay. No, that helps.

Timothy J. Gallagher

Again, the full year will show up in the fourth quarter but for purposes of comparison, I’ve given you guides for one-fourth of it.

Christian Wetherbee – Merrill Lynch

Okay. No, that makes sense thanks.

John C. Hellman

So Chris, the biggest movers from your numbers will be the impact of that short line tax credit and then the impact of currency which T.J. said was about $0.03 a quarter.

Christian Wetherbee – Merrill Lynch

Absolutely.

John C. Hellman

Those are the two big drivers versus how you are looking at the world.

Christian Wetherbee – Merrill Lynch

Okay. That’s helpful, and then I guess just on the pure pricing side that 9% it's a big number. How do you guys think about that? Are there any rebates from the class one guys on pricing rebates of fuel into that number or is that actual same store sales type of increase?

Timothy J. Gallagher

In the third quarter?

Christian Wetherbee – Merrill Lynch

Yes.

Timothy J. Gallagher

We’ve had very strong pricing all year and we’ve averaged about 200 basis points higher than the class one’s all year, and so this is just a continuation of the same trends.

John C. Hellman

And yes it includes rebates, yes absolutely.

Christian Wetherbee – Merrill Lynch

It does include. No, that’s helpful. I know you guys will release it in a couple of days here, but just any thoughts on kind of how things look in October. We don’t see your volumes quite as regularly just that you report them at least. You get a sense, obviously, with the economy getting as tough as it has over the last few weeks. What are you guys seeing? Is there any update you can give us there?

John C. Hellman

As you may be aware, we’ve been limping along with lumber enforced product shipments for almost two years now, so you’ll continue to see lightness there. We would expect that over the holidays, whether that’s Thanksgiving or Christmas, you’re going to see paper producers taking longer than normal outages and we’re structuring our services accordingly. That’s how you find us maintaining our margins, is that we’ll alter our service to meet that declined production schedule.

I would say versus the last quarter the steel market’s been a place that's been most affected negatively, but it’s not all parts of the steel market. So, we handle a lot of specialty steel for electricity transmission, tubular steel, much of that has actually been shipping pretty well but some of the commodity products have seen a falloff. You’ve probably seen in the press, that 50% to 60% of the blast furnaces in the United States were idle in the not-to-distant past. I would say in terms of how our business has been performing, the one new development has been in that area.

Christian Wetherbee – Merrill Lynch

Just as far as Mexico, any update as to when you might see the full exit there. I think you mentioned in your prepared comments that you’re continuing to actively seek the sale there.

John C. Hellman

Yes, everything takes six months longer, and then one expects. W do have an agreement there but it's never over until it’s over; wouldn’t be surprised if we were done in the fourth quarter, but I think we’ve been surprised more than once in Mexico. So, I wouldn’t be too adamant about my point of view but we do have an agreement and a buyer.

Operator

Our next question comes from Arthur Hatfield - Morgan, Keegan & Company, Inc.

Arthur Hatfield – Morgan, Keegan & Co., Inc.

I know you’re not giving guidance for next year, but if we think about next year with regards to the tax credit, the tax rate that you gave for Q4, is that a fair representation of where things should be next year?

John C. Hellman

Yes, that's pretty close. If you recall in 2007, we averaged a tax rate around 28%, so 28.7% is probably going to be pretty good.

Arthur Hatfield – Morgan, Keegan & Co., Inc.

Right. But I just wanted to make sure that I was kind of thinking correctly there. When you do the catch-up in Q4, I’m assuming that there’s no cash impact from that because all you’ve been doing is accruing taxes throughout the year?

John C. Hellman

When we go through the $10 million of tax credits there’s not going to be a $10 million cash impact in the fourth quarter.

Arthur Hatfield – Morgan, Keegan & Co., Inc.

Then just thinking about the 40^% of your revenue that has a more direct cyclical impact on your business, is there much you can do going forward other than what you’ve talked about with regards to costs if things were to soften further in those different businesses?

John C. Hellman

No, the beauty of our business model is that it’s structured very locally and specifically, and we can touch every train service in direct conversations with our regional operating managers, and so there are always things that we can be doing better. When volumes cross certain thresholds there are always train services that we can eliminate going from a certain number of days per week to a reduced number of days per week.

There’s always smarter things we can do on CapEx. I can tell you in regions that are being more, some of our regions have been unaffected by the current economic climate, but in those that have been more affected there are steps we’re taking with respect to capital expenditures for any element of discretionary CapEx we’ll reduce in order to maximize free cash flow in those regions.

So, the short answer there’s always things we can do and as you can tell based on our forecast future margins, we think we’ve got a pretty good handle on it.

Arthur Hatfield – Morgan, Keegan & Co., Inc.

Finally, on the Rail Safety Bill, is there anything there that you may see some of the costs that the class ones are going to incur longer-term kind of flow down to you at the level that you operate at?

John C. Hellman

We estimate that over the next seven years or so the positive train control requirements will cost us between $800,000 and $1 million for equipping our locomotives with some of the onboard equipment. So, that’s over a seven-year period a total of that amount. So, that’s based on rail lines that we own or operate over that have some co-mingling of passenger and freight. So, we have a much more limited exposure.

Operator

(Operator instructions) Our next question comes from Thomas Albrecht - Stephens Inc.

Thomas Albrecht - Stephens Inc.

On your $2.75 diesel assumption for the fourth quarter, isn’t diesel still above $3.00?

Timothy J. Gallagher

If you look at the retail you see on the street, yes it's just above $3.00 I've seen locally here, but what our regions are paying today in some cases is less than that, and so that's the blended average of October was higher, we're paying less now and so that's what we think the fourth quarter will be.

Thomas Albrecht - Stephens Inc.

Jack, back to one of the earlier questions on acquisitions, does some of your deliberate wording reflect your wanting to see maybe how some of these short lines performed in a more challenging environment or have you seen competitions started to reemerge or is there, I'm just trying to interpret something beyond what you might have said.

John C. Hellman

I think the caution reflect the fact that when you're making acquisitions in an environment in which a credit market is in the midst of unprecedented turmoil in borrowing spreads for other acquirers have widened significantly, and in a volatility which is unprecedented in the history of the S&P 500 and how that translates into an equity risk premium, one has to conclude that our weighted average cost to capital and how we think about buying assets has to be altered somewhat and that valuations should be lowered accordingly.

So, I think when you're in uncharted waters being cautious is a wise thing to do and it’s a new world out there and the competitors for those acquisition are probably trying to figure out what their weighted average cost to capital is right now to be brutally honest.

Thomas Albrecht - Stephens Inc.

So, at least you’re still thinking about your cost to capital can't comment on what others think about, but you never lost that discipline. T.J., could I get you to repeat one thing you were giving so many numbers. On the non-freight revenue breakdown of $9 million, I think you said $3 million were fuel sales and then you ran through a bunch of other stuff.

Timothy J. Gallagher

Sure, $3 million in higher fuel sales in Australia, $1.5 million in higher accruing revenue, and $1 million in higher iron ore services with the latter two again in Australia or actually all three of those in Australia. In addition, we had a $2 million increase in our US industrial switching in port railroad revenues. Recall that we start the commonwealth railways started ramping up in the second quarter and so part of that $2 million reflects the growth commonwealth as well as ports like Corpus Christi.

John C. Hellman

Incidentally, Tom, as long as you raised that topic something we didn't talk about was Galveston where we were fortunate enough to have de minimis direct damage to our rail operations in Galveston from the hurricane, we probably incurred a $250,000 of direct cost from damage, and what's happening there is there's a lot of export grain that goes through Galveston. That is not shipping right now but about 60% of it is shifted the Port of Corpus Christi instead and we operate the railroad in the Port of Corpus Christi, and so it's just by good fortune that that export grain traffic has shifted from one port to another.

Operator

We have no more questions in queue. I would now like to turn the conference back over to T.J. Gallagher.

Timothy J. Gallagher

Again, thanks very much for joining us today. This concludes our third quarter earnings call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!