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Genesee & Wyoming Inc. (NYSE:GWR)

Q3 2013 Earnings Conference Call

November 1, 2013 11:00 AM ET

Executives

Michael Williams - Director, Corporate Communications

Jack Hellmann - President and CEO

Tim Gallagher - CFO

Michael Miller - CCO

Analysts

Allison Landry - Credit Suisse

Scott Group - Wolfe Research

Jason Seidl - Cowen Securities

Kenneth Hoexter - Bank of America Merrill Lynch

Anthony Gallo - Wells Fargo

Justin Yagerman - Deutsche Bank

William Greene - Morgan Stanley

Justin Lung - Stevens

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Q3 Earnings Call. At this time, all participants are in a listen-only mode and then later we will conduct a question-and-answer session. The instructions will be given at that time. (Operator Instructions) As a reminder, the conference is being recorded.

And I would now like to turn the conference over to your host, Director of Corporate Communications, Mr. Michael Williams. Please go ahead, sir.

Michael Williams

Thank you for joining us today on Genesee & Wyoming’s Q3 2013 earnings call. Please note that we will be referring to a slide presentation during today’s call. These slides are posted on the Investor’s page of our website www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measures are likewise posted on the Investors page of our website.

We will start with 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, which provides a 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, 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 SEC 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 and expressly disclaim any duty to update any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law and you should recognize that this information is only accurate as of today’s date.

On the call today, we have three speakers, our President and CEO, Jack Hellmann; our Chief Financial Officer, T.J. Gallagher; and our Chief Commercial Officer, Michael Miller.

I will now turn the call over our President and CEO, Jack Hellmann.

Jack Hellmann

Thank you and welcome to G&W’s third quarter earnings call. As always, we’ll start our call this morning with safety. On Slide 3, you will see that we completed the third quarter of 2013 with an FRA reportable index of 0.7 injuries per 200,000 man hours. If you look at only our railroads, which is the apples-to-apples comparison with other freight railroads, we now have an index of 0.8.

Although our safety statistics took a step backward in the third quarter versus the first six months of the year, we are actually more comfortable today that we have created a sustainable safety culture at the former RailAmerica railroads. We have made significant changes in railroad level leadership. We continue to conduct intense safety reviews of railroads and we have also provided extensive field and classroom training to advance our culture of zero injuries.

Now let’s turn to financial results for the third quarter of 2013 and Slide 4. This slide lays out our third quarter results versus our guidance and provides some simple commentary on the variances. Third quarter revenues were in line with our expectations at $401 million, however our expenses were higher than we expected for two reasons.

First, we finalized the purchase accounting for the RailAmerica acquisition, which resulted in annual depreciation and amortization expense that is $4 million higher than before. As a result we had a true-up of $2 million for the first six months of 2013 and we also have $1 million of higher depreciation and amortization that related specifically to the third quarter.

Second, our cash expenses in the third quarter were about $4 million higher than we expected at the former RailAmerica railroads. Of this amount, $2.4 million related to the proactive cleanup of several railroads where we are accelerating changes to the safety and operating culture.

In a nutshell as we have continued to systemically assess the former RailAmerica properties, we found conditions in facilities and track at several railroads that are not up to G&W standards for safety and service. We found and fixed many of these conditions in August and September and also expect to incur an additional $1 million of similar cleanup expenses in the fourth quarter, before we are back to business as usual.

The other cash expense that was higher than expected in the third quarter was transportation, where we’re approximately $1.6 million higher than planned. These costs were a handful of former RailAmerica railroads that prove to be short of crews to handle improving traffic levels. As a result we began to hire and train new people this summer, while simultaneously paying extra for overtime, contractors, and car hire. This too will correct itself in the coming months but there is some lag due to the length of our hiring and training requirements.

Now turning to Slide 5, I’ve provided the schematic of one of our operating regions to highlight the focus of our cultural changes in safety and operations. Having already exceeded the expected overhead cost synergies from the RailAmerica acquisition and having completed the staffing of our operating regions we have been intensely focused on improvements at the individual railroads in order to improve operating conditions and enhance the service we provide to our customers.

As part of this process, we have now replaced 17 railroad general managers at the 45 railroads acquired from RailAmerica for a replacement rate of 40% since January 1st. With these changes I think that we are now very close to our new equilibrium railroad general managers in North America.

Turning to Slide 6, despite these higher than expected operating costs you will see that our third quarter financial results were still pretty good. Excluding this year's benefit from the short line tax credit, our third quarter adjusted diluted earnings per share were up 49%.

Now turning to Slide 7, our combined Company, revenues excluding the impact of foreign currency and third party fuel sales increased 11% in the third quarter. Of that revenue increase, about half was from Australia, led by iron ore shipments and where our business continues to perform very well.

The other half of the revenue increase was from North America led by steel and petroleum products. With respect to petroleum products, it is worth noting that while our volume increased 23% versus the third quarter 2012, we were roughly 2000 car loads weaker than the second quarter of 2013. This relative weakness largely reflects the sensitivity of our growing crude by rail traffic to the WTI-Brent spread.

Our third quarter adjusted operating ratio was higher than we expected at 73.8% for the reasons I have previously discussed. Now a few other observations as we look ahead. In agricultural products our outlook for shipments has improved in the United States, Canada and Australia. In the United States, with the exception of drought stricken Western Kansas and Missouri, we are expecting to handle a lot of agricultural products over the next six to nine months. This traffic should include increasing shipments to our railroads on the West Coast, at Grays Harbor Washington, the Gulf Coast at Corpus Christi in Galveston Texas and the East Coast at Brunswick, Georgia. In addition many of our railroads that serve the mid-west are anticipating significant volume growth based upon a record corn crop and a strong soybean crop.

In Canada the harvest also looks good and we expect higher winter wheat shipments to Quebec City later this year and into 2014, which would be a substantial improvement over last year. In Australia we're also expecting another strong grain harvest. After a 2012 to 2013 South Australian harvest of approximately 7 million tons, the current outlook for the 2013 to '14 harvest is 9 million tons. However please note that we’re in the midst of contract negotiations with our grain customer in Australia, so we could see some fluctuations in our 2014 volume.

In petroleum products, our outlook is a bit weaker for crude by rail given our experience in the third quarter as well as plant maintenance at one of the refineries that we serve. However the recent widening of the Brent WTI spread may help us do a bit better.

And finally, after the cleanup costs and hiring expenses at the RailAmerica railroads are behind us in the fourth quarter and as we continue to focus on reducing our combined company expenses, we remain comfortable that we'll be able to reach our target operating ratio of 72%.

Now turning to Slide 8 and our priorities for the remainder of 2013, which should look familiar. First is to enhance the safety and service culture of the newly acquired RailAmerica railroads. Second is to intensify the management of our costs across the combined company. Third is to sustain the good momentum of our Australian business. Fourth is to maximize commercial development across our new national footprint with particular focus on the energy sector in North America. Our fifth major priority is an extension of the U.S. short line tax credit beyond 2013, which currently adds 175 cosponsors in the house and 35 cosponsors in the Senate. And finally, we continue to be evaluating multiple investment and acquisition opportunities in several geographies.

And I would now like to turn the call over to our Chief Financial Officer, T.J. Gallagher. T.J.?

Tim Gallagher

Thanks, Jack, and good morning, everyone. I’ll start with Slide 9 and a revenue bridge from the third quarter of 2012 to the third quarter of 2013. Third quarter combined company revenues increased $28.1 million or 7.5%. Excluding the impact of FX and third party fuel sales, combined company revenues increased $38.9 million or 10.7%, primarily due to higher freight revenues with the growth split roughly one-half North America and one-half Australia.

Moving to Slide 10 and freight revenues, third quarter freight revenues increased a total of $27.4 million or 10.1%. Excluding FX combined company freight revenues were up $34.5 million or 13.1% due to both higher rates and volumes.

Now let's move to car loads on Slide 11. Coal and coke traffic was down 3,900 car loads or 5%. However sequentially third quarter coal lines increased 4,300 car loads or 5% over the second quarter of 2013, but were lower than last year's third quarter 2012 coal traffic, benefited from one-time export coal moves from Utah.

Our metal strapping increased 5,900 carloads or 15%, primarily due to stronger steel slab and pipe traffic in our Northeast and Southern regions. Our agricultural products were up 3,600 carloads or 7%, primarily due to increased grain volumes in Australia.

Our petroleum product traffic increased 4,800 carloads or 23%, primarily due to new crude oil traffic in our Pacific and southern regions. Finally, Metallic Ores were up 5,300 carloads, or 38% primarily due to the expansion of our iron ore traffic in Australia.

Now, moving to freight pricing on Slide 12. Our combined company average revenue per carload increased 3.2%. Higher fuel surcharges and changes in commodity mix increased average revenues per carload at 0.6% and 2.7% respectively, partially offset by the depreciation of the Canadian and Australian dollars, which combined reduced average revenues per carload by 2.6%.

Excluding these factors, our combined company average revenues per carload increased 2.5%. Average revenues per carload was adversely impacted by approximately 1 percentage point due to changes in customer mix within the other and agricultural products commodity groups. The driver within the other commodity group was the high volume of low rated class one detour trains, while in agricultural products the driver was the increase in Australian grain traffic, which has a relatively lower rate given the fixed variable contract structure.

Now, turning to Slide 13 and non-freight revenues. Excluding FX and the impact of third-party fuel sales in Australia, combined Company non-freight revenues were up about $4.4 million, or 4.5%, primarily due to higher switching revenues in Australia related to the expansion of our narrow gauge iron ore service, as well as higher switching revenues in North America.

On Slide 14, we show our operating ratio for the third quarter of 2013 and the same period in 2012. Our adjusted operating ratio in the third quarter was 73.8%, 120 basis point improvement year-over-year, but 130 basis points lower than our guidance for the reasons Jack has already discussed.

Now let’s turn to Slide 15 and guidance for the fourth quarter of 2013. 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 actual results to differ materially from our current expectations. These statements represent management’s expectations regarding future results as of today, November 1, 2013, and we do not undertake any obligation to update this information.

We expect fourth quarter revenues of approximately $400 million, the same as our expectations in August but with few moving parts. First, the Australian dollar is now a little bit stronger than it was when we last reported, but we now expect a slower ramp up of our crude by rail traffic in North America and lower Metallic Ores traffic in Australia due to mine specific issues. However, we now expect stronger agricultural products traffic.

We expect operating income in the range of $104 million to $108 million. Offsetting the higher Australian dollar exchange rate is in unfavorable change in the mix of freight traffic, the impact of the purchase accounting on depreciation and amortization, new hires on certain RailAmerica properties as well as cleanup of the RailAmerica cleanup activities. As a result we expect an operating ratio between 73% and 74% or about a 100 basis points higher than our previous expectations.

We expect our tax rate to be approximately 28% and excluding the impact of approximately $0.5 million in RailAmerica integration costs, our diluted earnings per share in the fourth quarter are expected to be in the range of $1.15 to $1.20 with diluted shares of $56.9 million.

Net interest expense is estimated at $14 million and depreciation and amortization is expected to be $37 million. Embedded within the consolidated guidance for the fourth quarter are Australian revenues in the range of $85 million to $90 million and an Australian operating ratio of approximately 69%. The wild cards in the fourth quarter will be how quickly North American agricultural traffic will increase, given the strong harvest, the Australian dollar exchange rate and the Brent WTI spread.

On Slide 16 you have supplemental information for our fourth quarter guidance. We expect carloads in the range of 470,000 to 480,000 the same as in August which reflects a year-over-year combined company carload growth of about 8% at the midpoint. Some of the biggest changes versus the prior year are as follows: first, we expect coal and coke traffic to increase about 12,000 carloads, largely due to stronger steam coal shipments in our Midwest or higher value in central regions.

Next agricultural products traffic in the fourth quarter is expected to increase 7,000 carloads, primarily due to higher volumes in Australia and the U.S. Petroliam products traffic is expected to increase 5,000 carloads, primarily due to higher crude shipments in our Pacific region and higher NGL shipments in our Ohio Valley region.

Metallic Ores traffic is expected to increase 5,000 carloads primarily due to iron ore traffic in Australia and minerals and stone traffic is expected to increase 4,000 carloads, primarily due to stronger North American salt and aggregates traffic.

We expect increases in freight pricing to be in the 3% to 4% range, excluding the impact of fuel, currency and mix changes. Diesel fuel is expected to be $3.40 per gallon and with respect to exchange rates; we expect the Australian dollar and Canadian dollars each to be $0.96 and the Euro to be worth of $0.36.

I’ll close with Slide 17 and a snapshot of our balance sheet. At the end of the third quarter, our debt to capitalization was approximately 44%, and we have $400 million of available capacity under revolver. Since the end of last year, we paid off approximately $150 million of debt.

And with that, I will open up the call for the questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question from the line of Allison Landry with Credit Suisse. Please go ahead.

Allison Landry - Credit Suisse

So, I guess you guys talked about your 72 OR target. Is that specifically a 2014 goal or sort of a longer-term goal?

Jack Hellmann

I think we should be able to get there in 2014. You can see how these numbers, we said previously we thought we would get there this year, but you could see based on what the nature of the specific variances are, that several of these things are going to go away and so sort of the normalized run rate should be back at that level anyway.

So, it may not be the first quarter because, I mean, I don't know yet because we haven't actually put together our budget for next year, but the first quarter expenses are often higher because of the winter. But it would, so we will see certainly by the second quarter should be there.

Allison Landry - Credit Suisse

Okay and the hiring and training costs, you seem to suggest that those would take a little bit longer, just given the nature of your programs?

Jack Hellmann

By the way our Chief Operating Officer, David Brown is here as well. He wasn’t introduced originally, but the nature of our -- the places where we ended up being discovering that we were short staffed and that we have been engaged in hiring, it takes about six months to get someone properly trained under our requirements to be safe, to be operating on our railroads and so that’s why there is some lag on it.

Allison Landry - Credit Suisse

Okay and then just one last question. Now that you've had 10 months of ownership of the RA railroads, looking back and relative to sort of your initial expectations, do you think that there is more or less operational improvement that you could squeeze out of the RA railroads, versus what you originally thought, and I guess in other words, did the previous management team extract most of the potential of improvement?

Jack Hellmann

Well in terms of the -- depending on how you define efficiencies, the overhead synergies have been bigger than we expected, and we've already realized those. Some of the operations have had specific opportunities for operating efficiency improvement. Others were underinvested in and the services that substandard to our customers; and the opportunities actually going to be spending some of this money and pulling traffic back onto the railroad that's currently not there.

And so that's what you're experiencing right now, it’s some of the places that we found in August and September, where places that frankly it didn't make economic sense of what was going on. They are places that should have had some more money spent and it should have had more service in place and the volume was there to be had here.

Allison Landry - Credit Suisse

Okay so maybe some additional efficiencies through driving more volume?

Jack Hellmann

Yes, you’re going to get more volume. Michael do you want to comment on that as well?

Michael Miller

No, clearly we have identified places where when we make these investments and service improvement occurs, we get that the confidence of the customer back. We have directly see volume growth. So I am very confident that as we continue to make these service improvements and invest in the infrastructure and get it back to where it should be based upon our standards and our customer requirements, we will continue to see. There is pent up demand there without question.

Operator

And our next question from the line of Chris Wetherbee with Citi. Please go ahead.

Chris Wetherbee - Citi

I just want to make sure, I understand so when think about some of specific investments on the RA railroads, that sort of ends in fourth quarter. So by the time we kind of lap into the first quarter of next year, most of those should be done. Besides the lingering training cost to employees, I am talking about more sort of infrastructure cost?

Jack Hellmann

Yes, that's exactly right. The kind of stuff that are being done are things like having serviceable toilets in locomotives and brush cutting that has been done in 18 months and shops that haven't been properly maintained for many years; and some acquisitions, which over the period of which they were required to get any ordinary course track maintenance.

So, these are one side. These aren’t systemic. These are one-time things that were just not done in order to keep the cost structure; to make the cost structure appear to be a little bit lower for a short period of time. But you fix them and you get on with life and then we will be back right where we were.

Chris Wetherbee - Citi

Okay and when you think about the pace of revenue from these railroads, do you get a sense that some of this business may have been lost in the relatively recently past or is it stuff that as you guys are kind of tuning up the network and trying to gain incremental business, you realize there is a stumbling block to capture that new contract? I’m just trying to give a rough sense of sort of how this progress has been happening?

Jack Hellmann

I think it’s both but I am going to let Michael answer that. Michael what do you think.

Michael Miller

Yes, I do think it’s both. Clearly as a service, product deteriorated overtime, particularly truck to rail traffic. Stuff that could go highway when highway. What we’re starting to see is some of that converting back to rail. You’re also seeing additional volume just to, confidence from the customer that service is there and then we're seeing natural increases as the economy slowly recovers. So I think it's a little bit of all that.

Tim Gallagher

Another data point, if you think about the growth we reported earlier in the year within North America is roughly split 50-50 between RailAmerica and G&W Properties. In the third quarter the growth was roughly two-thirds G&W, one-third RailAmerica. So there was a little bit of a slide and I think that was a direct function of some of the services that we're invested to fit.

Chris Wetherbee - Citi

That's helpful and then one quick follow-up, just switching gears to crude by rail for a second, just want to get rough sense of when you talk about the sensitivity to spreads and that certainly makes sense, where do feel sort of the break point is, where you get a little more interest from the customer to be moving? It seems like we've seen the spreads move-out, expand over the course of the last month or so, just want to get a rough sense; has business been picking up in response to that?

Jack Hellmann

T.J., you want to start and then Mike will go.

Tim Gallagher

I think first of all the Brent WTI spreads that we experienced last year and the first part of this year were unprecedented. And so in the $20 range which narrowed to near parity in July, I think right now they're about $10-$12. So I can't tell you the exact break point because these trends are relatively new. I would think that north of $10, there going to be more attractive more traffic flowing, but it's a little too early for us to say. Michael you have anything?

Michael Miller

No I think that $10 number's a pretty good number to stick by. We’re starting to see some things move as we get to that number. So I think that point of inflection probably changes depending upon [indiscernible], time of year, but I think $10 is a pretty good number to stick with.

Chris Wetherbee - Citi

Is your target for fourth quarter based around roughly the current spread? Roughly?

Jack Hellmann

Yes.

Tim Gallagher

Roughly, but that's, if we're going to be wrong that's why we highlighted that that's where we're going to be wrong. Maybe we're a little bit conservative because we were weaker than we expected in the third quarter but maybe we got it about right. It's very hard to tell.

Operator

We have a question from Scott Group with Wolfe Research. Please go ahead.

Scott Group - Wolfe Research

So Jack, I want to just ask you about the acquisition environment. So I haven't seen before or least in a little while you add in the caveat that you're going to pursue the acquisitions at the appropriate valuations. So maybe can you give us a sense of what's going on in the market? Do you feel like the valuations are getting a little frothy and maybe there aren't great opportunities right now? Are we reading too much into that?

Jack Hellmann

I think you're giving me too much credit for being like Alan Greenspan and picking my words that carefully. We'd never do a deal if we don't the valuations right. So that's kind of, I'm probably stating the obvious and don't even need to say that but having said that, there are, we're looking at several opportunities in several geographies from an acquisition standpoint right now and if the valuation is right we'll be successful and if not we won't.

Scott Group - Wolfe Research

Okay so you're not saying it's an environment like '07 where the valuations are just too high and you are not going to….

Jack Hellmann

No, no, we're not, I'm not implying that right now. There isn't as much bidding competition today. The credit markets may as equally lenient now, but there aren't as many bidders as there were then. That period of time when weren’t competitive, back in 2007 into '08, when things collapsed. that's not what I'm referring to, no.

Scott Group - Wolfe Research

Okay good to hear. In terms of some of the natural resource projects, things like that -- it feels we haven't had anything new come in, in terms of announcements in Australia and I feel like people aren’t expecting that but can you talk, is there still activity going on in Australia where you think that could be some projects coming or new projects and then can you give an update on Grays Harbor in for crude in any other crude projects that could be coming in the U.S.?

Jack Hellmann

Sure. We continue to be active in Australia. There are several opportunities we are working on. And we shall see. I would just leave it at that. Yes we are active right now our team in Australia is busy. In fact we are adding to our business development group down there right now, a senior person, in order to be able to handle the activity that we see both near and long-term. So there's a variety of things in a variety of geographies there. So Australia is interesting. With respect to Grays Harbor, Michael do you want to comment on that?

Michael Miller

Yes, as you probably aware I think its public information, there's three projects out there. Clearly they're still going through the permitting process. We stand ready to work with those projects. We just have to go through that permitting process and as you know, that could take six months, it could take 12, it could take 18, we just need to work the projects. And there are several other energy products out there we'll continue to work as well.

Jack Hellmann

It's still the busiest segment of our activity, are these energy products, including the ones that are more visible publicly like at Grays Harbor and then there’s others as well that are not visible.

Scott Group - Wolfe Research

Okay, great. And just last thing from Jack so one of the things that RailAmerica was doing really well was the non-freight revenue side. And wondering what you learned from that and if there is if you see some opportunities for some non-traditional non-freight revenue to start coming in more aggressively as we start thinking about ’14?

Jack Hellmann

The reality is always more complex in the perception I mean there are part of the non-freight revenue that were not sustainable they were assessorial charges being applied that were simply not sustainable from a customer standpoint anyone doing business for the customer for the long term is not going to be able to sustain some things that were being put in place, and so some of those things go away.

In the actual real estate area there have been some positive audits going on of our properties such that we think we’re going to be we’re going to be increasing easement income over time and we’ve already started to do that right now I think on a combined company basis we actually now have approaching $20 million of direct easement income effectively we’ve got many REIT there because this is very long term cash flow stuff. But I don’t think, that number will continue to grow. It will grow more rapidly than it thanks to the quality of the real estate team that we put together now in Jacksonville but the numbers are, it's not going to double or anything like that it’s going to be a nice increment layered in.

Scott Group - Wolfe Research

And the stuff that’s not sustainable have we cycled through that or is there still.

Jack Hellmann

That’s gone. And then as the trade-off in many times for that as you get rid of it focused on actually putting volume on the railroad for the long term because that’s the sustainable income it’s marketing share putting it on the railroad for the long haul not getting a short term buck from layering on an extra charge.

Operator

And we have a question from the line of Jason Seidl with Cowen Securities. Please go ahead.

Jason Seidl - Cowen Securities

Jack, TJ how are you guys this morning?

Jack Hellmann

Good.

Jason Seidl - Cowen Securities

Jack I guess you talked a lot about the potential bid opportunities on the crude to rail side. Could you maybe update us on how that looks and in putting some of the money to work in some of the RailAmerica lines will that enable you to bid on any of those projects?

Jack Hellmann

Well, there is a wide population set of crude by rail opportunity some exist at places where we currently serve where there is prospects for additional significant additional volumes then there is also brand new projects which had a longer lead time on them on existing properties. Then there is also an opportunity set in crude by rail which actually isn’t exactly on our railroads but we’re providing service in adjacent geographies from switching and loading terminal loading standpoint as well as the construction standpoint.

We’re actually bundling, we're actually looking to bundle our service in terms of build the yard, invest the capital, provide the switching services and that enable that new terminal to connect out to the Class 1 rail system. So there is a whole we’re attacking it from many different angles and in many different geographies, but the most prominent geographies are on the Gulf Coast the West Coast and we also have a project in California.

Jason Seidl - Cowen Securities

That’s great color thanks. What I'm looking at sort of the investment that you're putting into those RailAmerica facilities got me thinking about CapEx for ’14, are there more that you envision having to sort of bump up for sort of the 2014 CapEx level or did you sort of get what you had get to you already

Jack Hellmann

Most of the stuff we’re dealing with here isn’t structural capital issues, it’s more nickel and dime maintenance trying to take your expenses look better than they really are, so this is more ketchup operating expense rather than a up I structural capital expense so I wouldn’t read anything beyond that.

Jason Seidl - Cowen Securities

Okay, fantastic. Gentlemen, thank you for the time as always. I appreciate.

Operator

And we have a question from Ken Hoexter with Bank of America Merrill Lynch. Please go ahead.

Kenneth Hoexter - Bank of America Merrill Lynch

Great, good morning. TJ you talked a little bit before about some of the mix shifts you’re seeing given as you develop I guess some of the RailAmerica traffic now. Do you see that as maybe more permanent, did it maybe shift more faster than you had anticipated I guess as, or is that just different than what you’re seeing on the cost side?

Tim Gallagher

The mix shift I referenced for our fourth quarter guidance was really relative to the guidance we gave on August 1st. So that was a slower ramp of crude by rail expansion of our iron ore traffic in Australia there is broadly lower chemical traffic across all the properties little stuff here and there, and then incremental grain which is I mentioned earlier incremental grain in Australia that variable rate not a full average rate, and so it’s on the margin most profitable than railroad current North America. So it’s really all those factors combined it’s not anything structural or different than that.

Kenneth Hoexter - Bank of America Merrill Lynch

Okay, and then on the speaking of the Ozzy iron ore contract it seems our yields is that also variable whereas volumes ramp up your yields decline a bit or is that only on the grain side?

Tim Gallagher

It's also on the iron ore side.

Kenneth Hoexter - Bank of America Merrill Lynch

So we should continue to see has ramp-up that to see the average wheels come down a little bit further? Back from what they are a little bit further.

Tim Gallagher

A little bit.

Jack Hellmann

Actually it's complicated, I don't like it too specific but there is actually one part of the contract which is very, very high set straight for a variety of reasons and we don't even don't report those car loadings because it would be, kind of give, it will be misleading to think the revenues were going up that much when those car loads arrived, because it's such a high fixed proportion and that another piece where the fixed piece is a little bit lower and those are the car loads that we report.

And we have in metallic orders, in addition to the southern iron project that expanded this year we have three other metallic ore customers and so as their volumes fluctuate and they get in quarter that will that customer mix shift will also impact average revenues.

I mean what you can see through this is the Australian grain is a tough way to make a living, I mean it's very competitive and the rates are proportionately lower and so it's a much, much tougher business than the rest of our Australian business.

Kenneth Hoexter - Bank of America Merrill Lynch

That's helpful and then I guess same thing any thoughts now on the Tata Canadian contract in terms of ramp-up?

Jack Hellmann

Where we are on Tata, I forgot about that, we have received all those required permits and were finalizing the construction plans and we expect constructional start shortly some of it is actually already commenced on a piece of Tata's old railroad. We're going to have to contend with some winter weather which could cause some delay. I would, I think you're going to get that Q2 is what is going to come online is my guess. Depending on the winter. They've already had a blizzard up there. But it's still expected to proceed.

Operator

We have a question from the line of Anthony Gallo with Wells Fargo. Please go ahead.

Anthony Gallo - Wells Fargo

Did you mention the many read the time the timing of the actually that's not my, actually could you refresh us on the North America GWR our Ag business is versus RailAmerica and I am thinking about that in the context of the record harvest I just don't remember what the RailAmerica Ag market was like

Jack Hellmann

Hey Michael do you want to start with maybe review the former G&W and then take us through at in Ohio RailAmerica?

Michael Miller

Sure when you look at the legacy G&W roads versus the legacy RA roads clearly we’re much more levered on the RA properties. They have big footprint in Indiana and Ohio which is primarily the greenbelt. I don't know the exact percentages because have harvest last year was so poor we don't have a good comp, but clearly we're going to have more upside with the RA roads this year as they represent a much larger footprint in the greenbelt. We do have some negative exposure in Kansas with the Keio railroad that is primarily weak, suffered a severe drought earlier this year, so that was a little bit of negative headwind for us on the grain side.

But in general with the soybean and corn harvest being what it is projected we should see some significant upside in the fourth quarter in early next year.

Anthony Gallo - Wells Fargo

And suspect you have looked at those RA roads to make sure they are not the ones that need additional cleanup ahead of this?

Jack Hellmann

Fortunate the railroad themselves are in good shape.

Anthony Gallo - Wells Fargo

And then on a different subject back to crude on rail so a couple different pieces here you mentioned the Brent WTI spread challenge and that you have also mentioned some long-term investments that you're making I suspect that given your experience with the agricultural metal metallic business for you got fixed and variable components, is that a model that you'll use for this North America crude on rail?

Michael Miller

Yes. That is a fair statement. At the end or volume minimum volume requirements there's no question that given the potential variability that we need to be back.

Jack Hellmann

One other comment I'll make with respect to crude by rail we serve both the West Coast, the Gulf Coast and East Coast and so we are looking at Brent WTI spreads, we are looking at ANF like Alaska North Slope WTI spreads and then the Gulf coast as Louisiana Light Sweet so it's actually complicated and we'll look at each of spreads over time and very [indiscernible] conditions.

Anthony Gallo - Wells Fargo

Is this where having a national footprint but not necessarily contiguous railroads were the competitive advantage kicks in or am I not looking at that right?

Jack Hellmann

Well it's competitive and then you've got more real estate where the terminals can be located and so there's lot optionality there. And the other one we're actually just exploring more that's developing for us that we haven't talked about is in Utah, and the [indiscernible] crude as well and it's finding its way into the market I don't know Michael if you want to talk about that for a minute.

Michael Miller

The one thing about the national footprint it does give us access and some of the larger guys because we offer a bigger portfolio to them we are not just a one-off solution we can have a network solution for them. And also de-risk us a bit. Crude to one geography may drop down because the spread like Louisiana Sweet maybe tight and we may see more move to the West Coast with ANS spreads being better so it kind of [indiscernible] from that standpoint and then clearly as we look at like the UN 10 in Utah that Jack mention you're doing that very discounted crew bases there which makes that attractive in we feel like there's a great opportunity to develop that market in the future.

Operator

And we have a question from Justin Yagerman with Deutsche Bank. Please go ahead.

Justin Yagerman - Deutsche Bank

Was hoping you could give a little bit of color around commercial development in the U.S. right now I mean you talked about Australia but I know you guys started taking volumes from the fractionators in Ohio and I think you've got more heavily involved in driving business from the ground up as these different facilities get put into place. Maybe if you could talk a little bit about anything that you guys see in the hopper coming online over the next few quarters that you have line of sight on right now would be helpful in terms of getting us into organic growth rate.

Jack Hellmann

Michael do you want to talk about anything I mean we just talked a bit about energy and some of that energy is longer-term and some of it is near-term. Do want to talk about (style) for little bit?

Michael Miller

I mean, (style) has ramped up a little bit slower than we had anticipated, it’s primarily driven that they needed some additional pipeline capacity for all stake of byproducts. But that is actually coming online at the end of the fourth quarter. So, we feel good about that. We’ve got a couple other projects in the queue in the Utica area which we think we’ll be making some announcement very soon on and we also have another crude project that we’ve seen the producer actually start to break around. And we have pretty robust pipeline for other commodities as well.

I mean we feel very good about what we’ve got in our industrial development pipeline. As you know these projects take long to develop and they are never really done until the first car moves. But at least the project that we’ve actually that you’ve have seen hit the market, they started little bit slower than we anticipated but with some additional investments and we’re starting to see those ramp up so we feel pretty comfortable about what first quarter holds for us.

Justin Yagerman - Deutsche Bank

Sounds good. Jack question for you on the acquisition side, I know you guys are evaluating a bunch of things maybe you could talk about size even if you're not talking necessarily about what and where, in a post RailAmerica world obviously it's a little more difficult to move the dial so how you think about the opportunities that are out there from a sizing perspective on the M&A side?

Jack Hellmann

Well, it’s interesting I won’t answer it specifically but I will speak generally I mean what’s happened with the evaluation of the rail industry over the past decade is just that we use to be a company that did sort of $30 million to $50 million which kind of the sweet spot of the acquisitions when, probably decade ago.

But as the industry itself has, I guess as proverbial Renaissance has taken hold and the health of the rails the broader rail system and the discrete short line railroads themselves have taken off the valuations of each of those discrete railroads has grown and not probably not quite of fast as G&W has grown but they’ve had a big proportion that increased in their intrinsic value as well. So, that a decade ago that was worth 50 is probably now worth of 150.

So, that’s just kind of good luck in terms of our own business model as we’ve scaled up the health of the industries scaled up such that you continue to see good size opportunities for acquisitions.

Justin Yagerman - Deutsche Bank

Got it so kind of a 3X multiplier in terms of the size but that's coming more from valuation, or you think that the growth is tough question actually to ask.

Jack Hellmann

I think you're getting are there a enough good-sized opportunities out there to move the needle to give us the ability to incrementally deployed a couple hundred million dollars of capital per year in order to sustain a higher than normal growth, higher than sort of core growth the answer is yes. There continues to be a lot of, it's a combination of M&A, and equipment deployment under long-term contracts in Australia and Canada that provide that opportunity. The population said it has in no way diminished. The help of the rail industry has improved over time.

Justin Yagerman - Deutsche Bank

And then last question just in terms of the crude by rail opportunity, I know you answered bunch of questions on it but how big is that business for you right now and then how much of it is actually spread dependent or how much of it is covered by guaranteed minimums.

Jack Hellmann

Well, all crude by rail is spared dependent because crude oil is primarily bogging crude but in the future that will be probably Canadian crude coming down by rail as well and maybe somewhat Texas crude but over time there is going to be pipeline capacity for all these regions and price differentials and so crude by rail I think we believe is very great opportunity in the long term but it’s going to be more volatile with other types of traffic because it is spread dependent.

Michael Miller

The proportion of the petroleum products in the third quarter that was crude by rail which is 35%. We said last quarter is one third it was slightly higher sequentially in the third quarter, but it didn’t grow as much as we expected it’d grow, it grew more, it’s a bigger piece pie but it’s just listen as big growth. So that means roughly 9000 a quarter right now that was that did double or triple from last year? Tripled?

Jack Hellmann

Doubled.

Michael Miller

It doubled from the last year on the same timeframe.

Justin Yagerman - Deutsche Bank

Great thanks for your time

Operator

And we have a question from William Greene with Morgan Stanley. Please go ahead.

William Greene - Morgan Stanley

Hi, there good morning. Hey, Jack, some of the bigger rails have talked about 2014 pricing slowing which is a bit related to inflation and whatnot, now I know you didn't give 14 guidance here but when you look at your book of business in you think about a lower inflation rate potentially for the industry next year, should we anticipate a similar kind of slowdown in your pricing in the domestic market?

Jack Hellmann

Yes, you can assume that we are weighted average basket of Class I pricing in effect, in the US. And when you’ve blended all together, we did not give 2014 guidance but we are comfortable saying that 3% as a baseline assumption for next year is probably a good place to be. That’s to the chase for you.

William Greene - Morgan Stanley

Yes, exactly so one of the things that we often think about it, I think with GWR is that sort of baseline North America, your growth rate in EBIT probably approximated mid-teens so to speak if you assume kind of GDP like volumes maybe a little better three or 4% pricing and some productivity. But if the price is going to be lower doesn't mean you have to deploy more capital to sustain that growth rate next year or is that not really changed the strategy and also his business and is just here there some growth rates change a little.

Jack Hellmann

Yes, we can't control that the deployment number because maybe you’re right, if one number moves down another got to move up to compensate, so you either got to get it on the volume, like something like the housing market improving, which we hope happens, it had approved but it’s kind of flat for a while. So you either got get on the volume side or you got to deploy incremental capital, but we can't control the timing of the size of that, the railroads that we’re looking with their work and we’re not going to pay more just because we give one capital.

We, our little rate on the same, our evaluation, our valuation expectations are the same and it'll just come when it comes. So, what we have to do, I mean the good news is that we've got a national footprint which intrinsically over time should elevate our growth rate, you've got some properties that as you can tell based on the expenses in the quarter, have not been operating it an appropriate service levels for the customer base.

We should be getting a little bit of lift out of that over time. We saw that the summer frankly as we made some improvements on one railroad. Brak, you will see the volumes were up significantly, the next month that was August investment in September results so that itself we got probably as Michael said earlier, we've got some latent growth on some of the former RailAmerica properties independent of the economy.

William Greene - Morgan Stanley

Sorry, I kind of didn’t understand this part of your, but given the upgrades that you made to some of RailAmerica lines, does this have any impact on the synergies, does it enhance it or detractor just not related?

Jack Hellmann

I would say it’s not related, it’s a one-time catch up of expense, is all it is and then you back to your steady state assumptions on the underlying cost structure.

William Greene - Morgan Stanley

Okay, one question on acquisitions, if you were to make an acquisition outside of the territories you currently own rails into, does that add materially to corporate overhead like if they were non-Australian, non-North American, non-Netherlands kind of acquisitions or is it not really that way the structure is pretty capable of handling more geographies?

Jack Hellmann

Yes, that’s a good question. I would not think other than probably in the accounting function depending on the size of the transaction. The overhead would come from the target entity itself and maybe you would have some additional accounting experts to support it. But other than that, it would be a stand-alone G&A at that target entity. The organization currently structured is very scalable. We are scalable as we've ever been. We actually have a bench that's pretty deep to run acquisitions today and we didn't have a bench 12 months ago.

William Greene - Morgan Stanley

And one last one, sorry to ask conditional topic but crude by rail, are there any risks on regulatory from any of the incidents that occurred over this year that have caused maybe safety questions.

Jack Hellmann

I made clearly, this is, that the tragedy is going to change the regulation of the industry in some fashion and that remains to be played out is what I would say. David, do you want to say?

David Brown

Yes, I think, the largely what’s coming down in regulation for before regulation already things we’re already doing, so it’s not new requirement with regulated requirement instead of just operating new requirement.

William Greene - Morgan Stanley

Okay, thank you very much for the timing and insights, appreciated.

Operator

We have a question from Scott Group with Wolfe Research. Please go ahead.

Scott Group - Wolfe Research

Thanks, just one quick follow-up. So, Jack, as you guys have kind of done the work on figuring what RailAmerica properties need some cleaning up, any that you have come across that you think are just kind of bad properties that maybe are worth closing down or selling and not worth upgrading?

Jack Hellmann

No because the scale of these upgrades is I mean we're talking a lot about something which is a total $3.4 million of expense and so if you spread that across a bunch of properties you're not talking big enough numbers here that you were making that traumatic a decision, so I mean obviously the economics of a rail line we see don't make sense we'll shut it down but this specific, these specific expenses don’t play into that thought process.

Scott Group - Wolfe Research

Okay and are there any though generally that you think are on the economics just don't make sense?

Jack Hellmann

Trying to think, you know there's one that requires study I would say. It's a small one but there's one that requires study. As you'd imagine if you had 45 railroads there's always interesting things that you see.

Operator

And we have a question from Justin Lung with Stevens, please go ahead.

Justin Lung - Stevens

Thanks good morning guys. You just mentioned the crude train derailment we saw in Canada this summer it seems like some of the short lines might feel the need to step up insurance coverage after this event especially if they're hauling hazardous material so first I was wondering if you could just talk about your current insurance coverage because I believe it was renewed recently and second if you could discuss the potential opportunity this could create either on the M&A front?

Tim Gallagher

Sure, Justin this is TJ. We renewed our liability insurance globally during the summer, unfortunately it was about a month after the Lake Megantic tragedy from a renewal timing standpoint, liability rates in Canada were up about 33% and I think every railroad that renewed after that accident faced some significant increase. We currently insure our sales for a liability standpoint in the area just under $0.5 billion so it's pretty substantial so the capacity therefore in larger low capitalized public companies, I think smaller private companies have a more difficult time getting a lot of coverage.

But if the combination of customer requirements, interconnecting part you know rail partners change over time I think that could dramatically impact some of these short lines and their ability to continue, so they may wish to sell so that the whole value chain from end to end is properly insured.

Justin Lung - Stevens

Okay, great, that's helpful TJ and second one for Jack, it sounded like you were a bit more optimistic on what's going on in Australia, I was curious if the activity you're seeing was all related to iron ore projects in the Central Australia freight lane corridor or are you working on things in different commodity groups and different geographies within Australia.

Tim Gallagher

It’s all of the above; it's in our own backyard and other places too.

Justin Lung - Stevens

Okay great, and last one, you talked about some near term cost items with the former RailAmerica line and gave some good color there, but once you cycle through those the next quarter or so are there any there any other expense items on the horizon that would change your expectation that we see about 50% incremental margin on average in your North American business as you kind of rebuild density back to that prior peak volume level.

Tim Gallagher

No, I mean we don't but we also didn’t, we think we've assessed all that we've been systematically going through, 45 railroads and 7,500 track miles so it's probably not surprising that we unearth some areas of neglect but we didn't see those costs coming that we're talking about right now, and we think we’re far enough through the assessments and I'd be surprised if I saw anything beyond the incremental million that we plan to spend in the fourth quarter, but given that on August 1st I didn't see this 3.4 million coming, I couldn't tell you with absolute certainty that there couldn't be more but I don't expect anymore.

Operator

And Mr. Gallagher there are no further questions in queue, please continue.

Tim Gallagher

This concludes our third quarter 2013 earnings call, thank you very much for joining.

Operator

Thank you and ladies and gentlemen, this conference call will be made available for replay and that begins today at 1:00pm Eastern time, the replay of the conference runs until November the 30th at midnight Eastern, you can access the AT&T teleconference replay system by dialing 1-800-475-6701, please enter the replay access code 277-584. International participants may dial 320-365-3844, again those numbers, 1-800-475-6701 and international parties can dial 320-365-3844, the replay access code is 277-584. Well this concludes our conference call for today, thank you for your participation and for using AT&T executive teleconference, you may now disconnect.

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