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Executives

David Baggs - Assistant Vice President, Investor Relations

Michael Ward - Chairman, President and Chief Executive Officer

Clarence Gooden - Chief Sales and Marketing Officer

Tony Ingram - Chief Operating Officer

Oscar Munoz - Chief Financial Officer

Analysts

Edward Wolfe – Wolfe Research

Ken Hoexter – Merrill Lynch

Tom Wadewitz – JP Morgan

William Greene – Morgan Stanley

Chris Seraso – Credit Suisse

[Yong Kuan] – Barclays Capital

Matthew Troy – Citigroup

Randy Cousins – BMO Capital Markets

Jason Seidl – Dahlman Rose

John Larkin – Stifel, Nicolaus

Walter Spracklin – RBC Capital

CSX Corporation (CSX) Q2 2009 Earnings Call July 14, 2009 8:30 AM ET

Operator

(Operator Instructions) Welcome to the CSX Corporation Second Quarter 2009 Earnings Call. For opening remarks and introductions I would like to turn the call over to Mr. David Baggs, Assistant Vice President, Investor Relations for CSX Corporation.

David Baggs

Welcome to CSX Corporation’s Second Quarter 2009 Earnings Presentation. The presentation material that we’ll review this morning along with our quarterly financial report and our safety and service measurements are available on our website at www.CSX.com under the investor section. In addition, following the presentation a webcast and podcast replay will be available on the website.

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

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

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

Michael Ward

Last evening we reported second quarter earnings per share from continuing operations of $0.72 down 24% from the same period last year. As we examine the quarter we clearly see two distinct forces at work. First is an economy that continued to significantly impact our volumes and our revenues. Second is your company which responded by becoming even more productive and resilient.

Revenues were down 25% to $2.2 billion reflecting significantly lower volume and the affect of lower fuel recovery. In short, we saw what our customers saw, more tough times. But we also saw some signs of leveling off in many of our markets. At the same time we continued to deliver reliable service to our customers, allowing us to sell the value of rail transportation.

On our first quarter earnings call we described the swift actions we took to right size our network and serve our customers in response to the worsening economy. On today’s call you’ll hear how we are building on that success.

As we continue to do the right things on the expense side, our relentless focus on safety also continues. As a result, we are sending home more employees home safely at night which also allowed us to significantly reduce our casualty reserve. Our safety, service and productivity performance led to a second quarter operating ration of 73.4% and supported an EPS performance that was in line with 2007 levels.

While the economy continues to challenge all of us, your company is standing strong, we’re more focused than ever. The leaders you will be hearing from today are committed to fighting through this recession and coming out stronger on the other side.

With that, let’s examine the quarter more closely beginning with Clarence Gooden.

Clarence Gooden

In the second quarter 2009 we continued to feel the impact of the economic downturn across most of the markets that we serve. That said we are delivering a reliable service product for our customers even as we right size our network resources and remain focused on yield management. This morning I’ll highlight our revenue results for the quarter, the key driver of those results and also give you a sense of what we see for the remainder of 2009.

Let’s look at the results on the next slide. CSX revenue declined 25% to $2.2 billion due to continued broad based volume weakness. As you can see on the chart the affect of continued market based pricing and mix partially offset the impact of declining fuel recoveries. Price and mix accounted for $97 million in year over year revenue growth. Next, the impact from declining fuel prices further reduced revenues $223 million in the quarter. Yet the primary revenue story this quarter is the 21% volume decline which led to $596 million less in year over year revenue.

Turning to slide seven let’s take a closer look at overall volume changes across our major markets. Volume declined by double digits across all key market. In comparison with the first quarter of 2009 the most significant change in volume was in coal where we experienced a 21% decline in shipments. Volumes were down across all coal markets with large declines in exports.

Yet when looking at the other key markets that we serve you will see that we experienced year over year volume declines, mostly consistent with the first quarter. We believe that these three markets which account for nearly 75% of our traffic volume may be near the bottom. Yet before going further into the drivers of this volume change during the quarter let’s look at our pricing results on the next slide.

This slide shows that overall revenue per unit declined as continued core pricing growth was more than offset by reduced fuel surcharge revenues. The line on this chart highlight the year over year change in total revenue per unit which includes the impact of price, fuel, and mix. On this basis, revenue per unit declined 5.4%. At the same time, the bars on the chart, which represent our same store sales price increases were 6.6% for the quarter. Remember that these shipments represent approximately 75% of our total traffic base.

Looking ahead, and based on the strength of our first half performance we now expect to slightly exceed the upper end of our full year 2009 same store sales pricing guidance of 5% to 6%. Our improvements continue to reflect the value we are providing to our customers as well as the relative value of rail transportation. Here, rail customers are still paying only half of what they paid prior to 1981 including the impact of significantly higher fuel costs.

Now let’s take a look at each of the major markets that we serve, starting with coal. Quarterly coal revenues were $662 million a decrease of 20% primarily driven by lower volume, volume decline on weakness in global demand for export. In addition, utility coal shipments also declined or reduced demand, high inventories, and low natural gas prices. Lower domestic demand resulted from reduced electrical generation and declines in metallurgical goal, coke and iron ore due to weaker steel production.

Looking forward to the third quarter the decline in coal volume are expected to moderate. Lower domestic and global demand will continue to affect coal shipments. Stockpiles should remain above target levels and lower natural gas costs should continue to negatively impact coal use at utilities.

Turning to the next slide, let’s review the results in merchandise. Quarterly merchandise revenue decreased 26% to nearly $1.1 billion. We experienced the largest volume declines in metals, as steel production has been cut by half and on forest products and emerging markets where further housing and construction weakness have led to lower volumes. Phosphates also experienced declines on reduced domestic demand and inventory corrections more than offsetting growth in export shipments.

Looking forward to the third quarter we are seeing stabilization in several merchandise markets yet the industrial sector and housing and construction markets are expected to remain weak. Volume declines in our agricultural products are expected to be less severe as gain in ethanol shipments have partially offset other declines.

Turning to the next slide. Quarterly automotive revenue was $113 million 45% lower than last year. Lower consumer demand and inventory corrections have reduced automobile shipments. At the same time, plant shut downs continued and we’re further impacted by bankruptcy proceedings. This resulted in overall North American light vehicle production being down 45% in the second quarter.

As we look forward to the third quarter absolute volume levels are expected to stabilize when compared to the last quarter while year over year volume declines are expected to lessen on easier comparisons. At the same time, we will continue to work closely with our customers to adapt to the many production changes taking place including the ongoing industry restructuring, the growth of foreign brands and imports, and the startup of new plants.

Turning to our intermodal results, intermodal had second quarter revenue of $291 million down 24% versus 2008 driven by 14% decline in volume and 12% lower revenue per unit. The decline in volume was primarily related to continued weakness in the international market driven by the global economic turn down and declines in consumer spending.

Domestic volumes grew slightly as truck load conversions and new service offers helped offset declines in other segments. Revenue per unit was down in the quarter on decreased fuel recovery and a challenging over the road pricing environment.

As we look forward to the balance of 2009 we expect continued softness in international volumes reflecting weakness in global trade and consumption. In addition, the truck pricing environment is expected to remain challenging due to soft demand.

Now looking ahead, as you are well aware we are in the midst and an extraordinary economic downturn with much uncertainty still remains. That being said, let me share with you a few forward looking thoughts. Many markets appear to have stabilized at current levels with year over year declines in non-coal markets moderating slightly during the quarter.

Based on the current economic forecast we’d expect a double digit decline in our volume will continue yet at a slightly lesser rate in the third quarter. Also, excluding the impact of fuel surcharge our third quarter revenue outlook is unfavorable in eight of our 10 markets, flat in food and consumer and favorable in agricultural products. We continue to work closely with our customers in these challenging times to forecast traffic levels to make appropriate resource adjustments and to deliver reliable service.

We’d also continue to sell the value of rail transportation especially as shippers look for the most cost effective and environmentally friendly business solutions. This includes looking for new business opportunities as customer undergo change and prepare for an eventual turnaround in the economy.

In closing, we feel confident that our reliable service product and our attention to customer needs will position us for profitable volume growth as the economy rebounds. Thank you and now let me turn the presentation over to Tony to review our operating results.

Tony Ingram

In this difficult business environment our culture of leadership, discipline and execution keeps delivering. Our commitment to safety remains strong and will not waver in any business climate as we strive for leadership in one of the nation’s safest industry. We are driving productivity, responding quickly to lower volume and right sizing our resources to eliminate costs. Finally, even as we take these cost cutting actions, we are running the plan and service reliability remains strong.

Let’s take a look at some of the details. Slide 16 shows our safety performance including both personal injuries and train accidents. As you can see, our performance improved dramatically over the last several years and the trend continued in the second quarter. FRA personal injuries improved 6% to 1.22 for the quarter, that’s 25 fewer injuries compared to the previous year. FRA train accidents improved 16% reducing a rate of 2.22 an historical best quarter for CSX. Overall, our performance remains strong and we strive to eliminate all injuries and accidents, making a safe environment even safer for our employees and the public.

Now let’s turn to productivity and cost management. This graph shows the change in carloads and road crew starts over the last two quarters. Using the one plan we work to align our scheduled train network to current business levels. As a result, road crew starts, the crews that move trains across the system, are tracking lower with volume and were down 20% in the second quarter.

Let’s turn to the next slide. Fewer trains require fewer employees and locomotives. In our efforts to right size continued in the second quarter. Looking at train and engine employees on the left, the number of active employees was 17% lower in the quarter. As a result, a significant number of our employees are furloughed. I look forward to calling them back to work as attrition and business conditions warrant.

In addition, the active locomotive fleet was down 17% versus prior year and we currently have over 640 serviceable locomotives in storage. Right sizing efforts are not limited to the train network and road crews. We are making reduction in other areas as well.

Let’s turn to the next slide. As you can see on the chart, we continue to challenge the need for all resources, even those that are not considered volume variable in the short term. While the resources in the grey box do not track volume as closely, we have made significant reductions. Local crews, the crews that connect the yard to our customers, were down 16% in the quarter. Yard crews, the crews that switch cars in the yard and bill outbound trains, showed a 12% decline in the quarter. Finally, the number of mechanical employees decline 9%. This is because we have fewer locomotives and freight cars to maintain.

Now let’s look at our service measures. As we continue to align the train plan and resource levels to current business conditions, we remain focused on maintaining consistent service levels. Service reliability, measured by on time originations and arrivals, remained strong and continued to improve. Originations were 83% in the quarter, eight points higher then last year. In addition, arrivals improved to 81%.

Looking at our network performance, train velocity improved to 21.7 mph and the system remained very fluid. Average dwell time to 24.1 hours, primarily due to reduced number of train departures from our terminals.

Now let’s wrap up on slide 21. Safety performance remains strong. We continue to right size resources, drive productivity, and manage all of our costs to help offset revenue decline. The network is running well with fewer resources and service reliability remained stable. We will keep delivering results through leadership, discipline, and execution.

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

Oscar Munoz

Let me start with an overview of the quarters results on slide 23. As you can see, the top line was significantly impacted by declining business levels. Overall, revenue fell $722 million or 25% to $2.2 billion, driven principally by the 21% drop in traffic that Clarence discussed earlier. Expenses in the quarter declined $587 million or 27% to $1.6 billion, a little over half of this change was due to lower fuel prices with the remainder being driven by our safety, our productivity and our right sizing initiatives.

Operating income declined $135 million or 19% to $582 million and our continued cost discipline partially offset the revenue losses in the quarter. Move below the line, interest expense increased $6 million in the quarter, primarily due to incremental debt issued over the past 12 months. Next, other income decreased $7 million versus last year driven mainly by lower interest income. Please remember that with the sale of the Greenbrier during the quarter the resorts earnings both historical and current have been moved out of this line, other income, and are now included in discontinued operations.

Finishing out the results on this chart, the below the line items I just discussed along with our lower earnings and lower shares outstanding resulted in EPS from continuing operations of $0.72.

Let’s move to the next slide. As you know, fuel price once again played a significant role in our results so let’s look at the lag impact in the quarter. As we’ve discussed in the past, the lag in our fuel surcharge recovery is a benefit in times of falling fuel prices and a headwind in periods of rising fuel prices. After three consecutive quarters of decline fuel prices leveled off and started to increase.

As a result, we experienced a $33 million unfavorable lag impact in the second quarter. If you use the current forward curve, we would project the change in fuel prices to result in a neutral to slightly negative lag impact in this upcoming third quarter. As a reminder, and as you can see from the chart, we had a significant favorable lag in the second half of last year totaling close to $200 million. We will face tough year over year comparisons for the rest of 2009.

Let’s review the key drivers of our expense results on slide 25. Total expenses were down 27% or $587 million as I said earlier. You move from left to right on this chart, the first two bars on the chart reflect the impact of general market forces, non-fuel inflation of $21 million was more than offset by declining fuel prices which yielded a favorable impact of $219 million in the quarter.

As you continue across the chart the final two bars reflect management’s efforts over a sustained period of time. Let me start with the $70 million of year over year expense savings due to favorable casualty reserve adjustments in the quarter. As you know, our casualty reserves are periodically reviewed with formal semi-annual studies in the second and fourth quarters by management and an independent actuary.

The majority of this quarter’s adjustment is due to a reduction in the personal injury reserve that comes from a sustained multi-year decrease in both the number and severity of personal injury claims. In fact, since 2004 we’ve almost cut our FRA personal injury rate in half which shows the focus on employee and public safety that Tony and his team have instilled in the organization.

Another key driver in the quarter continues to be the positive impact from our right sizing and productivity initiatives. The team has responded quickly to changing business levels by storing assets, generating labor productivity and driving increased efficiency across the network. These actions have translated into significant savings, contributing to a benefit of $319 million in the quarter.

As we move to the next slide let’s take a look at our expenses in more detail starting with fuel which was our biggest variance. Total fuel cost declined $352 million or 66% versus last year. As you can see on the right hand side of the slide, the primary driver is of course price of fuel, which decreased expense by $219 million resulting from a $2.06 decrease in the average price per gallon.

Adding to this favorability was a $91 million impact of lower volume in the quarter. Looking at the chart to the left, fuel efficiency as measured by gallons per thousand gross ton miles improved 4% in the quarter and resulted in $22 million of year over year savings. The remaining variance in the quarter was driven by a $20 million decrease in non-locomotive fuel expense which also reflects lower fuel prices and volumes.

Let’s continue expenses on slide 27. MS&O expenses declined 28% or $145 million versus last year. The largest driver of this variance was the $70 million in net casualty reserve adjustment I mentioned earlier. We are also able to realize $41 million in volume related savings in areas such as terminal and expense and freight car repair.

Finally, cycling proxy related costs yielded an $18 million benefit in the quarter and the remaining $16 million variance represents a collection of several smaller items none of which are significant by themselves.

Let’s turn to labor and fringe on the next slide. Labor costs decreased 11% or $79 million from last year. The majority of this variance is driven by labor productivity savings of $70 million as a direct result of the reduction in overtime and headcount we discussed earlier. As you can see from the chart on the left, average headcount for the quarter declined by over 3,200 people reflecting our continued focus on adjusting our work force to current business levels. As Tony mentioned earlier we expect the furlough numbers to decline as business levels improve and normal attrition continues.

Finishing out the slide, the year over year reduction in incentive compensation provided a benefit of $16 million in the quarter and inflation was partially offset by various other cost savings.

On the next slide let me review the remaining expenses. All other expenses collectively decreased 3% or $11 million versus last year. Depreciation was up $2 million year over year as the net increase in our asset base was partially offset by lower depreciation rates on the life studies completed in 2008. Rent decreased $14 million due to substantial cost savings driven by the decline in volume year over year. Finally, inland transportation expense increased $1 million driven primarily by rate inflation from other railroads.

Now that we’ve reviewed our expense items in detail I would like to update you once again on our cost reduce score card as we move to slide 30. Although we’ve seen some signs of a bottom in most market segments the economy is still in a recession and the prospects a near term recovery are uncertain. As such, it is still critically important that we continue to manage our costs and respond to lower volume levels.

With two quarters of cost cutting efforts behind us in response to the downturn let’s review our results within each cost category on the right hand side of the chart. First, we were able to realize a 47% reduction in short term variable expenses versus last year. Fuel, of course, continues to be a large driver in this category due to lower prices and volume and increased efficiency.

In fact, as you might remember, when we first outlined our cost structure in the fourth quarter of 2008 we said long term variable costs would likely take two to three quarters to effect. As you can see these costs are down 17% roughly in line with our volume decline in the quarter. This performance is accomplished from a sustained focus on adjusting resources including our schedule network, our yard and local crews as well as local locomotives and freight cars as Tony mentioned.

Moving down the slide our fixed and indirect expenses decreased 14% driven in part by the reserve adjustments I mentioned earlier. Collectively we were able to reduce our expenses by 27% and when you normalize for fuel price impact and reserve adjustments total operating expenses declined 12% in the fourth quarter.

Now wrapping up on slide 31. As you look forward to the next quarter, as I mentioned earlier, we continue to project a headwind related to environment. We will face tough year over year comps due to significant favorable lag impact in the second half of last year. Of course, managing our cost structure has been and will continue to be our key focus. We’ve made significant progress in all areas of the business thus far including the long term variable expenses and we will continue to drive positive results going forward.

Equally as important as controlling costs, our balance sheet remained healthy. Our strong liquidity position and solid investment grade profile will continue to allow us to weather the current economic downturn. Collectively or focus on expense reduction, sustain improvement and safety and the superior value we provide to our customers allows us to maintain a stable operating ratio despite the challenging economic environment and positions us greatly to emerge as an even stronger company.

With that let me turn the presentation back over to Michael.

Michael Ward

The US rail industry is the model of the world. It’s the most cost effective, the most productive and the most efficient, and ships more commodities and goods than any other rail system on the planet. As such, our rail system provides US companies with unmatched competitive advantage. That advantage is absolutely essential as US companies and their work forces struggle to compete around the world.

The American work force cannot afford for our nation to turn the rail industry back to the days of excessive regulations. In those pre-stagers days one out of every four railroads was in bankruptcy or on the verge of bankruptcy. Service to customers suffered and the infrastructure was in a state of disrepair.

Let’s talk about how rail infrastructure gets paid for and have a fact based conversation about rail pricing. A recent report showed that in the nearly 20 years since 1990 rail prices on average have increased at a rate of just over 1% per year. In sharp contrast the major customer groups who are demanding rail re-regulation have increased their prices they charge their customer by up to seven times that number. Just to be clear, the re-regulation proponents are growing their own pricing sharply more year in and year out then we are.

They need deal with inflation, meet payrolls, provide ever better service and invest for safety in the future and so do the US rails. That’s why it’s so important that we and the rest of the rail industry continue to have a good instructive dialogue in Washington. Our collective goal should be a transportation policy that fits the need of US industry and the essential freight rail network over the long term. With a growing population, more and more people will consume more goods and those goods have to be moved.

The best way to do that by far is rail transportation. It takes trucks off congested highways and is better for the environment. Its projected there will be a dramatic increase in freight rail traffic over the next 25 years. That expansion will require mostly private funding, sound tax policy, and public private infrastructure partnerships to make the nation’s rail system even more competitive.

For all the right reasons, infrastructure is now a key focus of our Washington lawmakers. I believe there’s a growing recognition that investments in rail infrastructure, combined with a balanced regulatory environment are essential.

Infrastructure is only part of the solutions that railroads provide. We employ thousands of highly skilled and dedicated employees who make America move. In recent months, as is the case throughout American industry our employees have had to make significant sacrifices as we have made the difficult decisions to withstand the headwinds of this economy. To their great credit CSX employees have improved their safety and on time performance during this tough period.

As I said at the beginning of this call, this team has shown in these difficult times it remains highly committed to providing you with significant long term value for your investment. If you look closely at what our people have accomplished in this environment I trust you’ll agree that we are positioned to just that.

Now we’d like to turn it open for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Edward Wolfe – Wolfe Research

Edward Wolfe – Wolfe Research

In the slide where you talked about 6.6% same store yield net of fuel you said that’s about 75% of your traffic. What are you seeing on the other 25% on new business or changed business what are rates net of fuel looking like?

Clarence Gooden

I think they’re looking pretty strong as a matter of fact coming in. What we’re seeing in the same store sales is a lot of resourcing of products where some companies have closed down production at some facilities and shifted them to other facilities. Where that has occurred and it’s not measured as same store sales we’ve seen some very strong pricing.

Edward Wolfe – Wolfe Research

What are you seeing new business though and new business that’s competitive that’s come in that doesn’t exist in the network, what’s the pricing like and what was that looking like say a year ago?

Clarence Gooden

New business I guess is a term we’ve got to define here. Where we’ve had business that has been in the highway competitive mode or in some cases barge competitive we’ve seen on new business some compression from where we had been in general. What we’ve not done is sacrifice price overall to bring volume on to the railroad mainly because we wanted to stay focused on our need to reinvest. We are having to reinvest both in this infrastructure and the technology. There have been some cases where we’ve just elected not to go after some new business.

Edward Wolfe – Wolfe Research

When you say some compression can you just give, was it six points a year ago and its three points now is there some magnitude you can give to it?

Clarence Gooden

I can’t. I wish I could.

Edward Wolfe – Wolfe Research

On coal, the domestic utility tonnage down 11%, can you break it down roughly how much of that’s demand, how much is that gas substitution, how much of that’s high stockpiles. You made the comment that you expect it to be less worse in third quarter, can you discuss that as well.

Clarence Gooden

In the third quarter it’ll be somewhere between what it was in the first quarter meaning lower than the first quarter or better than what it was in the second quarter. What we’ve seen is when those gas prices fall, first below $5.00 then below $4.00 the marginal dispatch units come off line. Secondly, in the Southeastern part of our network and in the East in general, electric generation has been down about 7%. Then I don’t have the coal burn number right off the top of my head but its almost double what that is where it’s been surplaced by natural gas. The third factor we’re seeing is the utilities are essentially taking what they’re contractually obligated to take.

Edward Wolfe – Wolfe Research

I don’t understand why do you expect it to be less worse than in between first and second. What are you seeing?

Clarence Gooden

We’re seeing a couple of things that’s occurred. Some of the utilities have told us that they’re going to have to pick up their deliveries in the second half of this year versus what they had in the first half to meet their obligations so we’re seeing that happen. There’s been a little up tick in the export market, not much, but a slight up tick that’s come to what our customers are giving us in terms of projections.

Operator

Your next question comes from Ken Hoexter – Merrill Lynch

Ken Hoexter – Merrill Lynch

If we can wrap up on what you were saying on Washington, is there any that you can see kind of timetable as far as the introduction of the Rockefeller Bill or any progress being made on that or is it still kind of ongoing discussions?

Michael Ward

Still ongoing discussions. As you know, the coal bill was dealing with the anti-trust issues being melded in with the Senate Commerce Committee and Senator Rockefeller’s potential Bill. That Bill has not been released; we have no indication of when it will be. Obviously there are a lot of things on the plate for Congress right now with clean air legislation; as well the healthcare debate is going to occur. There’s some risk that those may not get adequate airing, i.e. the rail bill may not get out this year but at this point we’re not seeing anything coming out but we don’t know anything more then that.

Ken Hoexter – Merrill Lynch

You mentioned the employees furlough, was there a number on that? Your thoughts on CapEx when you think about as slow as the market it right are you looking to pull back more on that CapEx then you did?

Michael Ward

We have about 2,600 employees on furlough now. We will be calling a few of those back for both the regular attrition we’re seeing as well as some needs for vacation challenges or opportunities. On the CapEx we continue to be in the pace we had said earlier of roughly $1.6 billion this year, continuing to build that infrastructure for the eventual recovery so we’re not pulling back further on that.

Operator

Your next question comes from Tom Wadewitz – JP Morgan

Tom Wadewitz – JP Morgan

I wanted to see if you could give a little more perspective on the volume outlook. I think there’s some expectation out there that there’s a pretty big sequential ramp in auto production in third quarter versus second. Clarence you didn’t really comment on that. I wonder if you’re expecting that and if that’s going to have much of an impact on your volumes in third quarter. Also in terms of your comments on volumes you said signs of stability were close to a bottom. Aside from what you said on coal, are there actual customer indications of a pick up in volume or is it truly just that volumes aren’t getting worse.

Clarence Gooden

Let me start with the automotive first. Wards automotive is projecting that the third quarter production will be somewhere around 1.5 to 1.6 million units and that contrasts to around 1.1 million units in the second quarter. We think that one; inventories are down in general about 35% on a year over year basis. Two, there’ll be less plant down time and more replenishing of those automotive inventories. Three, we’re not quite sure about the fourth quarter yet because it depends on what automobile sales do in the third quarter that’ll drive those fourth quarter productions.

Secondly, on your question about what signs are we seeing that things are near the bottom. Steel capacity has moved from about 42% utilization to about 49% utilization and that’s the re-servicing of the service centers. Second, in our phosphate and fertilizer business we’ve seen the high inventories that were happening in the Midwest are being absorbed. Some of the major merchants have had to take some write downs to absorb those inventories. They’ve been absorbed over the last six to 10 months.

We think that the US buyers right now are waiting for the Canadian/Chinese negotiations to finalize for phosphates and fertilizers in third and fourth quarters. Somewhere around the fourth quarter to the first quarter we’ll see the rebuilding of those phosphate supplies going forward. All in all, it looks to us like most of these markets are stabilizing they’re at pretty much where they’re going to be on the down side barring any unforeseen circumstances.

Tom Wadewitz – JP Morgan

Do you have any preliminary thoughts on a broad framework for how we might look at 2010 pricing? I know it’s a little bit early to talk about that but do you think there’s much of a change from what you’re seeing this year and any thoughts on how we might look at 2010 pricing.

Clarence Gooden

First I think what we’ve said on pricing going forward in 2010 and beyond is that we will beat inflation. As we get closer to the end of this year, 2009, we’ll update you on how we think that looks. Having said that, we’re not going to find ourselves in a situation of where we’re sacrificing this price lever. There’s too much involved here with our capital expenditures and technology enhancement that we have to have so we will expect to have a strong pricing environment in 2010.

Operator

Your next question comes from William Greene – Morgan Stanley

William Greene – Morgan Stanley

Typically at this time of year what percent of your business is actually already locked in for the next year in terms of a price?

Clarence Gooden

Very little. We’re right now getting into negotiating phases with the customers for the contracts for next year so we’re heavily weighted in those negotiations as you’ll recall from last year in the second half of the year. In the economic environment we’re going to find ourselves in if you are a customer you kind of want to string this along a little bit here to see where things are going. If you’re in our shoes you want to aggressively go after a contract, try to get it tied up at a substantial price increase. We’re sort of like in that dance right now. We’ll know more as we move along.

William Greene – Morgan Stanley

You mentioned some of the reasons you think things are going to stabilize. Is this typically how you see things play out in an economic recovery or do you usually see steel go first and this sort of stuff or what’s the typical rebound look like in terms of where do we see signs of a pick up first.

Clarence Gooden

I don’t know that I would characterize this economic downturn as a typical economic downturn. First it was lead by housing, second by automotive and finally by a credit market collapse. So it’s difficult to say where you’ll first see it return. I do believe that once you see consumer spending start to improve you’ll see more of the consumer goods, more of the international goods start to recover. Second will be in the steel area which will indicate construction is moving up. Finally it’ll be in the housing market that’ll be the last.

William Greene – Morgan Stanley

Are you surprised by how strong your domestic intermodal has been? What’s driving that is that just new business from truckload carriers?

Clarence Gooden

It’s a couple of factors that’s driving it. One is one of our truckload partners has increased their shipments significantly between the West Coast and Central Ohio and in between the Kansas City area and Central Ohio. Secondly, one of our truckload partners has increased their market share in use of intermodal between Chicago and our new Chambersburg facility. The third factor that’s been driving it is West Coast transloads of international containers into domestic containers has had a significant impact on that domestic business.

William Greene – Morgan Stanley

How many cars per week do you think the network is currently resourced for?

Tony Ingram

When you say resources are you talking about car loadings or cars online?

William Greene – Morgan Stanley

I’m basically trying to get at where your volumes are today, so car loadings, is the network over or under resourced for where the volumes are today?

Tony Ingram

We’re way under capacity right now. How much we can add to that is probably another 15% to 20% that’s the portion that we got down plus we’ve added capacity. Our network hasn’t been tested beyond where we were when the decline started. There’s a lot of capacity. We got 36,000 cars stored, that’s about 30,000 serviceable cars. We’ve got about 215,000 cars online this morning that includes a lot of those 36,000 cars. Right now under these present conditions capacities are our least worries.

Michael Ward

Tony and his team have really driven the resources to match the demand I think quite extraordinarily for a heavy fixed cost business like ours. We have the resources adequately sized for what’s there. When it does rebound it quickly has the ability to bring out those locomotives out of storage, cars out of storage and recall the employees. We keep very close eye on making sure we’re right sized on the resources. As we’ve said before, as it does rebound we don’t think it necessarily comes back, the costs come back on a one on one basis with the efficiencies we’ve been bringing out of this.

Operator

Your next question comes from Chris Seraso – Credit Suisse

Chris Seraso – Credit Suisse

As it relates to regulation I’m interested in your view on arbitration. We saw an unfavorable result with one of our neighbors to the north who has to deal with arbitration. Do you think that’s in the cards for the US rail system?

Michael Ward

The dialogue that’s been in place so far has not been on Canadian style binding arbitration. It’s been much more around what’s the appropriate cost of capital, is it replacement cost what do you do with potentially bottle necks or reciprocal switching. It’s been more around those kinds of concepts. Streamlining perhaps some of the SPB processes as the SPB has been doing to make sure that the customers are getting quicker answers to their queries. No, I’ve not seen that in the dialogue as of yet.

Chris Seraso – Credit Suisse

On the casualty reserve clearly you’ve made pretty steady progress on the safety but should we expect improvements of this magnitude to the reserve then at the same time what do you think is a normal level that we should expect on the MS&O line in general either as a percent of sales or in dollars?

Oscar Munoz

As far as the safety improvement that Tony and his team have driven over the past five to six years it’s been pretty phenomenal so that rate of decline has been great. We are now leveling off at a point where we are right near industry leadership. That is a potential area that may limit some of the impact going forward. Again, a loss development factor has other things besides just frequency. Severity and cost therein so I think there’ll be continued adjustments of this magnitude, possibly not but again in a couple of years as the performance continues we’ll see something again but don’t know what it is at this point.

Michael Ward

That will continue second quarter and fourth quarter.

Oscar Munoz

The scheduled process and accountability. As far as MS&O I don’t know that we’re giving any specific guidance on line items. That is an interesting line because there is materials and supplies which are easily able to forecast, it’s the “O” or other that’s kind of a difficult issue that tends to move with business with issues like litigation or safety so it’s hard to kind of pinpoint a specific run rate on that. We’ll have to continue to give you as much transparency and let you do some of the work.

Operator

Your next question comes from [Yong Kuan] – Barclays Capital

[Yong Kuan] – Barclays Capital

On your core pricing that you talked about on the same store basis you said it’s around 6.6% in Q2. What would that look like if you had to adjust for mix as well?

Clarence Gooden

That number is already adjusted for mix. It’s adjusted for fuel and mix impact so it’s measured by the same margin, same destination, same commodity, and same car type.

[Yong Kuan] – Barclays Capital

I’m just looking at the footnote and it said its same store price increases excludes impacts from fuel and mix. Is there just something I’m missing there?

Clarence Gooden

That’s what I’m saying, it excludes it.

[Yong Kuan] – Barclays Capital

My question was more along the lines if you had to adjust for the mix impact as well do you know what the same store price would look like adjusted for the mix?

Oscar Munoz

It’s a very small amount. The predominate factor is fuel. Mix is almost immaterial.

Operator

Your next question comes from Matthew Troy – Citigroup

Matthew Troy – Citigroup

On the legislative front I was interested in your comments before obviously projecting timing is difficult but to the extent of your dialogue you’ve spent a lot of time in Washington have those folks gone dark now that they’ve been ask to merge or marry their agendas or are you still invited to the table and talking is part of the compromise legislation process. Are they kind of behind closed doors at the moment?

Michael Ward

There is still ongoing dialogue but some of it is them doing their internal deliberations as well. I’m sure when they feel they have a bill that protects the ability of the railroads to invest for the future as well as address some of the customer concerns they will bring that out. We have no sense of when that timing is at this point.

Matthew Troy – Citigroup

It’s your sense there’ll be another round of negotiations that would include the railroads prior to introduction or is it just a waiting game and they’ll release whatever draft they choose. What your sense in terms of process, is there another round that involves you or is it kind of locked and loaded and we’ll what they introduce?

Michael Ward

I think they’ve gotten most of the input they were seeking from both the railroads and the customer base at this point and they’re in their own deliberations by and large.

Matthew Troy – Citigroup

On intermodal obviously expectations for sequential pick up in auto due to seasonality. If we’re bouncing along the bottom here, normal seasonal patterns would probably resemble years past. There’s an expectation that there would be a peak shipping season or maybe a mogul shipping season being smaller. Are you hearing from customers any internal dialogue about wanting to fasten your needing capacity either for back to school or start to build into the back half of the year or are those discussions not happening yet.

Clarence Gooden

One is we have not heard any from people. Two is our expectation for a fall peak is very minimal. Three is that as Tony mentioned, we’ve got a lot of capacity not only at CSX but in the rail network in general. Any surge that would possibly get as a country here in the third or fourth quarter we’re well adapted and equipped to take care of it.

Matthew Troy – Citigroup

But not hearing anything yet in terms of intensions.

Clarence Gooden

No.

Matthew Troy – Citigroup

In terms of the headcount obviously very good progress there just matching the crew starts almost point for point but the volume declines. Just curious what indicates that we do get a pick up in volumes? What is your historical call back success rate is it 70%, 80%. What is your hit rate in getting them back? Help me in terms of process, how quickly can those folks be brought back online to handle traffic. Just trying to get a sense of the headcount issue when bandwidth restriction when volumes do pick up.

Tony Ingram

It’s different in different environments. Right now our call back rate was probably much greater the people that are furloughed then we would be if we were in high economic times. Right now we’re probably getting at least 75% or 80% back call back according to our agreement its like a 30 day call back. We watch this by location daily and we got a pretty good feel on how that would happen on the call back rate.

Matthew Troy – Citigroup

Once you call someone back is it a two week retrain, is it a three week, is it based on seniority, how does that work tactically?

Tony Ingram

Normally it’s about a 15 day call back but it’s according to how long the person has been off on this training, how long he may have been working at the time we had to relieve him. It varies and we watch all that at different locations. Some locations where we’ve had to furlough pretty deep we got a lot of seasoned people getting those back wouldn’t be much of a problem. Some places where we’ve had to hire and have a lot of young people that we just call obviously we do a lot of training before we turn them loose. We watch those areas and we do have our training center geared up on a notice to go it we have to do that.

Matthew Troy – Citigroup

Trying to level set expectations we’ve kind of hit the point now where the market is out in the weeks parsing weekly traffic data which can be a tenuous exercise at best. In terms of broader expectations you’ve articulated what you expect business to do in the third quarter but should we be looking for a sequential ramp linearly July, August, September or my expectation is July would be pretty dead month, the numbers could be bad then improvement would be back end loaded. Not looking for month by month guidance, just trying to level set expectations. How do you see the months shaping up vaguely or broadly in terms of the seasonality and where we should expect to see some kind of improvement relative to 2Q?

Clarence Gooden

I think you should start to see it more loaded to the back half of the quarter then the first half of the quarter. We’re already through a couple weeks here of July and you’re in your normal July, doldrums or however you want to characterize it but I think it picks up sequentially as we move into the buying season of August or back to school in September.

Operator

Your next question comes from Randy Cousins – BMO Capital Markets

Randy Cousins – BMO Capital Markets

One of the problems you guys have had is that you’ve been chasing falling volumes. I want to Oscar’s slide number 30. Obviously the short term variable matches the volume reductions. As volumes have now seemed to have stabilized and we look at the $452 million for long term variable and the fixed at $736 million is there some more money to come out in terms of savings if we use that kind at the base like given that we seem to now have some volume stabilization.

Oscar Munoz

Thinking of that long term variable cost and the two to three quarters to affect it, if you think of the timing back in ’08 when we said that and the results you’re seeing in this quarter which I think are in line roughly in line with volume I think the quarter declines you’ve seen in this particular quarter Q2 some of those benefits will continue in the for instance third quarter. After that again we’ll have to see where volume kind of continues.

Randy Cousins – BMO Capital Markets

Is there another $50 or $100 million of costs to come out you’ve not stabilized the volumes and the cost cutting initiatives catch up or less than that?

Oscar Munoz

That’s probably a little specific and broad for me to answer on an open call. Again, the cost focus that we’ve had is one that will continue.

Randy Cousins – BMO Capital Markets

With reference to RPUs I’m kind of noticing that we seem to have some stabilization in the intermodal RPU so the second quarter is for the international is 443 versus six month at 444, the domestic is at 745 versus 735 for the six months. Would it be fair to say that on a go forward basis that you expect RPU in the intermodal business to stay at this level or do you see additional downward pressure coming?

Clarence Gooden

On the international side I do not see additional downward pressure coming. As a matter of fact when you take fuel surcharge out it’s been very positive story for us. Depends on what happens on the domestic side with highway competition. I think what you’re seeing occur there is that the truckers are about as low as some of are going to be able to go and still survive. I think it’s pretty much stabilized about where it’s going to be.

Randy Cousins – BMO Capital Markets

Our thinking in terms of modeling on a go forward for the balance of this year these are probably pretty good numbers to use as an RPU basis for the intermodal franchise?

Clarence Gooden

I think that’s right expect you’ve got to remember now that the RPU base is on this externally reported numbers is going to have fuel surcharge in them. The fuel surcharge is going to be significantly different here in the second half of this year versus second half last year as Oscar mentioned earlier.

Randy Cousins – BMO Capital Markets

With reference to this segmented data looking at the OR for the intermodal business do you guys see it’s at $87.6 million in the quarter? Do you see that as like stabilizing, improving, how should we think about that? If you could offer it up the same way on the rail side, OR is at $71.2 million again there was a bit of the $70 million win but how should we think about OR trends for the various business units.

Oscar Munoz

At this point in time as we look at the business going forward it’s hard to really forecast and so we’re not prepared to give any guidance at that level.

Operator

Your next question comes from Jason Seidl – Dahlman Rose

Jason Seidl – Dahlman Rose

When you look at the 6.6% base pricing that you have, pretty impressive and you’re guiding up above your previous range. However, do you think there’s a little bit of danger in that given the current environment in Washington, understandably that rates are not where they need to be in 1980. Do you think there’s a little bit of danger that you might be pushing a little bit too hard right now?

Michael Ward

No, I don’t think so. If you look at the value proposition of what we offer to our customers we think we have a very good value proposition as they’re looking to save money in this environment they’re finding rail to be attractive. We drew out the price of the value we create and we do as Clarence said if we’re going to make the infrastructure investments in our country and our customer’s need we need to retain the ability to have these kinds of returns to allow us to continue to invest $1.6 million this year.

I think when we talk to the policy makers in Washington they do understand the importance of that and to make sure that we continue to make those kinds of investments.

Jason Seidl – Dahlman Rose

You brought up replacement costs in terms of the discussions in Washington. How feasible do you think that is to actually be pushed through?

Michael Ward

I think it’s certainly something that has very good rationale behind it. As you know with a large stand alone rate cases they basically are on a replacement cost basis. It’s not a consensual challenge we do need to replace this infrastructure much of which has a number of years on it and the cost have gone up significantly to replace bridges and those sorts of infrastructure needs. The challenge is not the conceptual part its how do we build a modeling framework that allows us to adequately capture that. We think that that is possible and should be done.

Operator

Your next question comes from John Larkin – Stifel, Nicolaus

John Larkin – Stifel, Nicolaus

I had a more detailed question on intermodal pricing particularly on the domestic side. It’s no secret that the shippers re-bid a lot of their truck load and LTL traffic as well as their intermodal traffic in the first half of the year. What was your mindset with respect to working with the IMCs and the truckload partners if they chose to perhaps go after a bid aggressively with price reduction? Did you share in that with them or was it really their decision to make in terms of how much of their own margin they wanted to sacrifice?

Clarence Gooden

As you know it goes both ways. We give a little; they have to give a little to get some of the business that they’ve got. That’s one of the reasons you saw some of those domestic numbers over the last couple of quarters decline.

John Larkin – Stifel, Nicolaus

You have given some in some cases where you think it’s important to hold on to the business, is that a fair way to think of it?

Clarence Gooden

That’s a fair way to think of it.

John Larkin – Stifel, Nicolaus

Back to Washington for just a second. Interestingly some of the same legislators that are talking about the rail competition bill are also involved in the surface transportation bill. In their initial objectives for that bill which in theory is going to move forward late this year if they can over ride the Obama administrations wish to delay it by 18 months, there was a thought that they wanted to between say 2010 and 2020 shift somewhere between 10% and 20% of the highway traffic over to other modes presumably mostly to rail and that there would be some government policy associated with that that would sort of make it more economically attractive to you all to add capacity and so forth.

Do you have any clarity as to what they may be talking about is it investment tax credits, public/private partnerships, what exactly do you think they have in mind?

Michael Ward

I’ll applaud the house transportation and infrastructure committee and Congressman Overstar for taking that broader perspective of not just the highway funding but looking at all transportation infrastructure that’s required. I think that really is reinforcing the fact that we do need to look at the rail infrastructure and I think it’ll take the form of some public/private partnership and maybe some specific targeted funding at intermodal movements which helps relieve some of that highway congestion and we would hope eventually and investment tax credit but it probably wouldn’t be in that transportation reauthorization.

The question is does is move through in this congress because is not under the Obama administration but as well the Senate leadership is under Senator Boxer has also said that they thought an 18 month continuing resolution was the proper vehicle at this point. I don’t pretend to know how they will work that out but clearly Congressman Overstar wants to move forward with it. We do applaud the emphasis on intermodal and rail infrastructure within that bill.

John Larkin – Stifel, Nicolaus

Your geographic competitor has had a fairly long list of what I would call strategic marketing initiatives that they’ve announced over the last few years. The most recent of which might be a move up into New England and the Boston area fairly aggressive intermodal move down into Florida, a coordinated effort with one of the Canadian carriers to move freight more south between Chicago and St. Louis more fluidly. Are any of these projects or are they in total a bit of a threat to you in terms of perhaps losing a little bit of market share and how do you think about protecting yourself from those strategic marketing initiatives.

Michael Ward

I think we offer a very good quality product out there. I think a little additional competition we’re still going to be offering a great product. We have the better routes in most of those markets so we think we’ll be able to compete quite well with those.

John Larkin – Stifel, Nicolaus

Have you seen any pressure so far with respect to some of those projects that have been moving along a little more rapidly?

Michael Ward

No we haven’t.

Operator

Your next question comes from Walter Spracklin – RBC Capital

Walter Spracklin – RBC Capital

You guys have pointed quite a bit to the great end route you’ve had in terms of safety and service gains over the course of this period and of course when we talk about those some of the push back that we get is that its sort of just brushed off as being volume driven and that these gains are certainly achievable on lower volumes. You guys have gone at great lengths to show that it’s beyond that. Can you give us a little bit more discussion about when volumes come back what kind of safety service and efficiency efforts or gains that you’ve made can you hold on to even in a higher volume environment?

Tony Ingram

We develop a train plan based on volume and as the train plan is running now we’re running less trains as you well know. It also requires a lot of times making a lot of additional switching moves to make these longer trains. Obviously we reduce trains by 20% you’re going to create some volume out there and you’re going to do some improvement on your line of road. We feel like through our one plan the technology we’ve added to it, it gives us a better look of how to build trains and how to speck trains and how to run trains as well as dispatching the crews and the locomotives.

We feel pretty comfortable we can bring a lot of that volume back with very little additional resources or eating at capacity. As far as our safety performance, we strive our safety performance as far as our strong leadership our people are very, very cognizant of leading the people, being close to the people, getting them working in a safe manner, running the trains in a safe manner in case we drop a chemical load or something in a neighborhood. We’re all cognizant of that type of safety performance.

The leadership that we’ve developed in the last three or four years has been very strong especially during the time that we had to show that we had a lot of leadership in reducing our costs in this down economy I think will continue. Obviously the numbers are not going to be as big as they were because were in last place and we’re pushing first place. Going forward we’ll continue to have those type of leadership and as our leaderships gets much more experienced going forward then we should continue the improvements.

Oscar Munoz

The way Tony likes to say it to the team is, in essence, expenses will not come back on a one for one basis. Michael mentioned it earlier today. The scorecard and the transparency around that scorecard that we’ve established is something we fully expect to continue even as the recovery begins. It’s not just a downward scorecard its one on the upside so that we monitor those things to make you life a little easier as you talk to your clients around that particular subject.

Walter Spracklin – RBC Capital

Switching over to pricing now in terms what you’ve been able to achieve in the last little while pushing above the 5% to 6% range. We’re going into a half now where the fuel surcharge is a lot lower so pushing through and therefore getting that price increase through might be a little bit more difficult. You’re guiding now above the 6% is that more a reflection of having done better than the 6% the first half or now that you’re going in the back end weighted of your price negotiations are you feeling comfortable that you can continue to get above the 6% range in the back half on your renewals that you achieve in the back half.

Clarence Gooden

I don’t’ want to say that I’m going to get above 6% on the back half because our guidance was for full year that we would exceed 5% or 6%. Having said that obviously the math in the first half is very favorable for us. Secondly, as we said earlier there we expect that they continue a good robust pricing environment. We expect to get value for the rail product that we’re delivering. Given the fact that our prices are still on a historical basis about half of what they’ve been over the last 29 or so years we think that we can maintain a very strong pricing presence in the second half.

Walter Spracklin – RBC Capital

Is an investment tax credit in lieu of pricing a minimal to you guys if your returns are identical at the end of the day would you expect a tax credit in lieu of increased pricing?

Michael Ward

If we had to choose between the two we would take the market place pricing that’s available to us in the service we provide. I think it would be sound public policy though to also give us the investment tax credit to incent us to invest even more for the future.

Operator

This concludes today’s teleconference.

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Source: CSX Corporation Q2 2009 Earnings Call Transcript
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