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Kansas City Southern (NYSE:KSU)

Q2 2011 Earnings Call

July 21, 2011 5:00 p.m. ET

Executives

Michael Haverty – Chairman, Chief Executive Officer

Dave Starling – President, Chief Operating Officer

Pat Ottensmeyer – Executive Vice President Sales & Marketing

Michael Upchurch – Executive Vice President, Chief Financial Officer

Analysts

Bill Green – Morgan Stanley Smith Barney

Allison Landry – Credit Suisse

Jason Seidl – Dahlman Rose and Company

Scott Group – Wolfe, Trahan & Company

Matt Troy – Cisco Hanna International Group

Scott [Notts] – Goldman Sachs

[Brad Belco] – Stephens, Inc.

Tom [Waveless]

Ken Hoexter – Vilanch

Anthony Gallo – Wells Fargo

Scott Nichols – Joseph, Rosen and Co.

Keith Shoemaker – Morningstar

Seth Lowery - Citigroup

Art Hatfield – Morgan Keegan

Operator

Greetings, and welcome to the Kansas City Southern second quarter 2011 earnings conference call. (Operator Instructions).

This presentation includes statements concerning potential future events involving the company, which could actually materially differ from the events that actually occur. The differences could be caused by a number of factors including those factors identified in the risk factors section of the company’s Form 10-K for the year ended December 31st, 2010 filed with the SEC. The company will not update any forward looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found the KCS website at www.kcsouthern.com.

It is now my pleasure to introduce your host, Michael Havety, Executive Chairman of Kansas City Southern. Thank you Mr. Havety, you may now begin.

Michael Haverty

Okay, thank you very much, and welcome to the second quarter earnings presentation. The management team that will be presenting today will be Dave Starling, the President and CEO, Pat Ottensmeyer, EVP Sales and Marketing, Mike Upchurch, EVP and CFO. Dave Starling will also introduce a couple of other key players that will be available for questions and answers following the presentations.

If you’re following on the website, turn to slide number five. You see the second quarter results. I’m not going to go through those numbers. They’re all self-explanatory.

Today, Starling will be talking about guidance here in a minute, and talk specifically about some departmental achievements that have taken place over the last year and a half. So what I’d like to do is maybe cover things from a big pictures standpoint.

First of all, this is the best second quarter performance in the history of the company. And it is the best operating ratio performance in the history for any quarter. And that’s pretty significant because historically, our performance, as with most railroads, you start out the first quarter slower. Second quarter is better. Thirds improves, and fourth is usually the best. So to have best operating ratio ever for our company in the second quarter, I think is pretty significant.

The second thing that I would like to comment about is that we have for the last year and a half talked quite frequently about becoming an investment grade security. And Dave and Mike Upchurch will go into a lot more detail talking about restructuring of the balance sheet and things that have taken place over the last year and a half.

But again, from the big picture standpoint, we are significantly – have moved significantly down the field on moving towards being an investment grade security. If you looked over the last year and a half, you keep seeing our ratings are improving all the time. And certainly our liquidity cash flow is improving. And the rating agencies are taking note of that.

The recent revolver in term loan that we did actually were investment grade. Obviously, they’re highly collaterized with the last revolver. The last term loan we had was not investment grade. So at least, we got started. We’ve got a ways to go. But I think we’re going to see significant improvement going forward. And I think this quarter is again a testament to what this management team has been able to accomplish through the execution of the plan.

With that Dave, I’m going to turn it over to you.

Dave Starling

Okay, thanks Mike. And as Mike referenced, we’ve got two other people that will be on the call today. Jose Zozaya, our President and Executive Representative is on the phone from Mexico City and available for questions. And also, Dave Ebbercht, our Vice President of Operations.

With that, I’d like to refer to the first slide. As you can see by the update chart, KCS is tracking very well to the guidance we provided in January. Revenue growth for the first half was 14%, which was a bit above our low double digit guidance.

Looking ahead to our second half book of business, we now feel confident that our 2011 will finish higher than the first half revenues. Our volumes are up 7%, which is at the upper end of our mid-[inaudible] guidance. Pricing has been and should continue to be stable in the mid-single digit range. Our operating ratio for first half improved within the range we projected despite some fuel cost headwinds.

As you’re well aware, KCS recovers over 95% of fuel. However, the lack effective recovery can affect our OR at any specific point and time.

Before moving forward in the presentation, I’ve got a few comments to make. The performance of our three main functional areas; marketing, operations, and finance, have driven our success in the first half. But just as importantly, they have set the stage for any future growth in many ways more robust than what you’ve seen from KCS over the last year and a half.

Marketing has filled the pipeline with both new and expanded existing business opportunities. Some of these opportunities are occurring right now like Cross Border, Intra-US, and Intra-Mexico Intermodal. These business segments begin to take off in 2010. And will continue to grow for many years at a significantly greater rate than the industry average.

Now, Pat Ottensmeyer and his team are putting in place a number of new business opportunities like potential crude oil traffic from the upper Midwest and Canada to Port Arthur. Here we are in July, 2011. We can already look at robust new business coming on in 2012 and 2013.

Not only do we feel confident about our revenue outlook, having this information now gives us time to plan for deploying our resources and ways that will maximize efficiency and profitability.

Speaking of efficiency leads me to operations. Over the last two years, KCS has increased in average screen speed by approximately 1.5 miles per hour, while simultaneously including average terminal dwell time by about one hour. These may not sound like big numbers to you, but in the railroad industry, they’re significant.

What is especially impressive about those achievements is that our volumes were 32% higher in the second quarter of 2011 than they were in the second quarter of 2009. And on top of that, operations accomplished these improvements while engaged in a very aggressive track maintenance program.

Rail programs of this magnitude typically affect capacity and velocity, but that has not been the case in the Dave [Vebric] and his operating team.

The accomplishment to the finance area has been every bit as impressive. At the end of 2009, we were staring at a mountain of debt maturities totally over $1.1 billion coming due in 2012 and 2013. If you fast forward to the end of 2012 and factor in the elimination of the remaining 13% notes we intend to take out in December, KCS will have no debt maturing until 2015. And even that’s a very manageable $275 million.

Furthermore, the debt maturity profile has been stretched out from 2016 to 2021. And as Mike referred, Mike Upchurch and his team renegotiated the company’s bank term loan and revolver facilities extending both out to 2017 at lower interest rates than prior facilities.

The new bank agreement also eliminates the stringent restrictions on how the company can use its cash. Going forward, this provides greater flexibility on how we can deploy our cash, which will facilitate company business growth and provide more options for shareholder returns.

In addition, our improved capital structure provides KCS with a greater-than-ever level of protection to weather economic downturns that could impact our business levels.

I must admit, it’s been a pleasure for me to be able to report that we’re hitting our targets. And in some cases, exceeding them. It’s even better to look at the talent, knowledge, and spirit with interdepartmental cooperation exhibited by key managers throughout the organization. And to be able to say KCS is poised to achieve even more in the days ahead.

With that, I’ll turn to a few of our key operating metrics. The second quarter operating ratio improvement shows a positive trend of higher volumes and improved operating ratio.

The OR improved by 2.1 points from the first quarter. And 0.7 of a point from a year ago. We’re very satisfied with our OR improvement especially when you factor in we had a very substantial personal injury accrual adjustment a year ago. And we’ve had to deal with rising fuel costs in the first half of the year. We feel good about achieving continued OR improvement as 2011 progresses.

The next graph illustrates the continued favorable relationship. KCS has continued improving Linehaul revenue and operating expenses. Again, the point of this graph is to illustrate that as we grow revenues, we are continuing to do a good job of controlling our expenses.

The next slide tells much of the same story. As our Linehaul revenues grow, we keep in tight control over operating expenses per Crewstart. KCS has an excellent training service planning process, which allows us to adjust to network changes very quickly.

On the next slide, I mentioned our system velocity and dwell times earlier; two instances where level bars on charts were good things. We’re maintaining numbers in both areas that are among the best in the industry. And doing it while growing volumes at a faster pace than industry average.

The next slide shows a continued gain in productivity. We set a new company record in the second quarter improving on the previous record set in the fourth quarter of last year. Headcount control is still major focus and will remain so.

Finally, the next slide, PCRC continues to improve with volumes up [inaudible] % and revenues up 24%. The operating ratio continues to be better than that any other transcontinental railroad we know about.

With that, I’ll turn it over to Pat Ottensmeyer.

Pat Ottensmeyer

Thank you Dave, and good afternoon everyone.

I will begin my comments on Slide 16, which is a recap of the revenues and volumes for the quarter.

As you saw earlier, our revenues for the second quarter were $534.9 million, which was a 16% increase over last year. Our revenue growth was driven by a 7% increase in carloads and 9% increase in average revenue per unit to over $1,000 in the quarter.

Mike mentioned that the second quarter operating ratio was the best in the history of the company. Total revenue and total carloads in this quarter were also records for any quarter in Kansas City Southern history.

Moving to Slide 17, you can see the factors contributing to revenue growth quarter. And as you can see from this slide, all of the factors contributed positively to revenue growth. You’ll see that same store pricing contributed $14 million of the revenue increase over last year. The pool of revenue related to same store type movement was $270 million, or roughly 60% of our total linehaul revenue. So the increase during the quarter in so called core pricing was 5.4%.

So moving to Slide 19 would be our familiar presentation of same store pricing. This slide shows you that linehaul revenue for loaded car mile, which excludes fuel, mix, and foreign exchange, on a same store basis increased by 5.4% over the second quarter of last year. And was higher in every business unit than last year’s levels.

Just to point out a reference, the slide that Dave talked about earlier with the mid-year guidance, the 5.5% increase in same store pricing was for the first half. This slide references the second quarter.

I want to comment about intermodal pricing. You can see intermodal showed the lowest increase in same store pricing. And that reflects the conscious decision on our part to focus on building volume and improving contribution. We have been aggressively going after truck conversion and achieving higher capacity utilization on our intermodal trains rather than taking rate increases at this time.

This is not to suggest that we are discounting our cross border product, but we are more focused on keeping what business we have converted, building density, improving capacity utilization, all of which will have a more powerful effect on growth and profitability of our intermodal business going forward.

Another data point that we have reported in the past to measure pricing environment is the rate increases on contracts renewed or re-priced during the quarter. During the second quarter, we had contracts or bids totally approximately $160 million in annual linehaul revenue. And the weighted average rate increase from this business was 6%. This will obviously have an impact on same store sales in future periods.

One other comment is that we had no material legacy contracts renewed during 2011. Substantially, all of our legacy contracts were renegotiated in 2010, most of them at the beginning of 2010.

So based on all of this, our conclusion is that we continue to see a good pricing environment. And that going forward, we believe pricing increases will continue to be in the mid-single digit range, which is consistent with the guidance Dave gave earlier.

Moving onto Slide 18, this shows business unit performance in greater detail. As you heard earlier, revenues on a consolidated basis up 16%. Volume up 7%. Average revenue per unit up 9. Revenue and RPU was higher in every business unit over last year. I’m going to spend just a little time on this page, and a little bit more on the outlook for each business unit a little later.

Growth in chemicals and petroleum was driven by strong cross border and export fuel shipments in Mexico as well as strong cross border plastics traffic.

Our industrial and consumer business experienced strong revenue growth in paper, metals, and appliances. The 11% RPU growth was due to pricing and greater utilization of higher capacity equipment primarily for paper and appliances. Again, I’ll touch on that in a little bit more detail later.

Ag and minerals continued to be impacted by the weather. Even though cross border traffic increased from the first quarter, they were still just about flat to last year. The RPU increase was a function of pricing and fuel. Growth in our coal business was driven by revenue per unit, which was primarily a function of increased length of haul.

A higher percentage of our traffic went to our long haul power plants during the quarter. We do not expect this to continue to add to the magnitude that we saw in the second quarter.

Intermodal growth was a function of volume, pricing, and higher length of fall on cross border growth.

Automotive revenues were higher as a result of very strong volume growth, longer length of haul, which includes the impact of new cross border business secured since last year. And utilization of higher capacity auto max equipment.

Slide 21 shows our cross border revenue trends, which you may recall have been negatively impacted in the previous three quarters by flooding and weaker cross border grain shipments. As you can see, that trend has reversed. And we experienced very strong growth in cross border revenue in the second quarter. All business units equaled or exceeded their previous all-time high in cross border revenues.

As I indicated on the first quarter call back in April, our cross border grain business began to come back in the second quarter. And this may be negatively impacted in the third quarter due to flood conditions in the upper Midwest and Missouri River Basin. But in spite of this, we expect to see continued growth in cross border revenues going forward.

Moving to Slide 22, we have a bit more detail on the intermodal portion of our cross border business. On Slide 22, you can see that we’re continuing to experience rapid growth in our intermodal cross border traffic. The volume increased by 40% year-over-year in the first half. And revenue increased by 55%.

For those of you who saw our Houston presentation on June 29th, these growth rates are lower than what we showed for the first quarter alone. But I’d like to point out that since we opened the Victoria Rosenburg line in the second quarter of 2009, we have experienced significant volume and revenue increases in every quarter, expect for the third quarter of 2010 when we experienced hurricane-related outages. The percentage increases will come down simply because the base is growing very rapidly.

I’d like to make a comment about the new cross border trucking pilot programs since we get a fair number of questions on this topic, and how it will impact our cross border truck to rail conversion.

You may remember when the 2007 pilot program was in effect; only 29 Mexican trucking companies participated. And the vast majority of the movements were limited to border zones. Since 2007, there have been new impediments to greater participation including the new CSA safety rules. We continue to believe that the truck to rail conversion thesis is still very valid on the cross border traffic. And that any pilot program will have little or no impact on our ability to convert this traffic.

Moving to Slide 23, this shows growth in the first half of 2011 related to Lazaro Cardenas traffic. Again, very strong growth over last year, 35% on volumes and 39% on revenues. In 2010, the port of Lazaro Cardenas was the fastest growing container port in North America. And our traffic volumes certainly reflect that.

We believe this exceptional growth will continue as Hutchison moves ahead with their expansion plans for the existing terminal. And the second container terminal concession comes on line over the next few years.

The second concession is still expected to be awarded by the end of 2011. The long-term outlook obviously for the port of Lazaro Cardenas remains to be very positive.

Moving to Slide 22, you can see that our outlook for both the third quarter and the full year is very strong, very positive. Even with potential third quarter flooding impact in Ag, and minerals, and coal, year-over-year comps for the third quarter should be strong particularly in Ag and minerals because of the impact of Hurricane Alex last year.

I’ll just touch again on some of the key drivers for each business. Growth in chemicals will be driven by strong cross border petroleum and plastic shipments, similar to what we’ve seen so far this year.

Industrial and commercial products will be driver by paper and appliances, which by the way, also represents an excellent example of one of our yield management initiatives to generate round trip utilization, greater round trip utilization of our high cube boxcar fleet with paper going into Mexico and appliances coming north.

Our steel business should also be strong due to strength in auto production, appliances, and energy, and a recent expansion of one of our steel plants that we serve.

Ag and minerals will see growth in cross border grain. The strength in the second half will not overcome weakness in the first half, which explains the only single plus on this page. We do expect growth year-over-year more in the single digits than teens.

Coal will be positively impacted in the third quarter, and we believe for the rest of the year by missed shipments due to flooding in the second quarter. And heavy demand that we expect due to the extreme heat experience in our markets.

Intermodal growth of course will be driving by market share gains as a result of truck conversions and growth in the overall market.

And finally, in our auto business, we expect that to continue to be very strong as Mexican production or production of plants that we serve in Mexico, has grown more rapidly than the overall market.

Putting all this together as Dave mentioned earlier, we expect revenue growth in the second half of 2011 to be stronger than the 14% we recorded in the first half. For the most part, our customers are telling us that they expect growth in shipments in the back half of the year. In addition, pricing trends are positive. And new opportunities continue to develop on the KCS network.

So I’ll wrap up with Slide 25. Again, we expect the economy in both the U.S. and Mexico to remain on a moderate growth mode in the second half. There are certainly signals in the economy that are suggesting some signs of weakness. But our customers are generally telling us that they expect growth in shipments for the rest of the year.

We expect pricing to be in line with our prior mid-single digit guidance.

Cross border business is back from the growth path, and we expect that to continue.

Longer term, our outlook continues to be very positive. Dave mentioned this earlier, but I listed some of the more significant drivers of our long-term growth outlook on this slide. I will not spend any time on this call discussing them. We went into a fair amount of detail on each of these points and opportunities in our June 29th cross border update webcast. That presentation is still available for replay on our website if anyone is interested.

Finally, during the second quarter, we completed a customer satisfaction survey, the first we’ve done in a few years, in which we polled about one-third of our top 200 customers. We’re going to make this an ongoing process where we will touch base with each of our top customers on an annual basis. We will poll another third of our account base in the fall.

I’m not going to go into a lot of detail on this survey since it was really a benchmark against which we will measure trends and customer service going forward. I will say the results were very positive, with a high 90%-plus of our customers indication their service meets their needs. And that we’re providing value to their operations.

With that, I will turn it over to Mike Upchurch.

Mike Upchurch

Thanks Pat, and I’ll start my comments with the condensed income statement on Slide 25. As Pat has already mentioned, revenues increased 16% to a record quarterly level of $535 million consisting a volume growth of 7% and revenue unit growth of 9%.

We believe our volume growth will be 60% to 70% better this quarter than the rest of the industry, which we estimate to be around 4%. And is reflective of the tremendous growth driven franchise KCS has built over the years.

Operating expenses increased 15% primarily due to a 33% increase in fuel price. As Dave has already mentioned, our second quarter OR is the best ever, $71.7.

Our year-over-year incremental margins is a bit lower in second quarter at 33%. Please note, we did have approximately a $2.5 million negative fuel lag along with about $7 million in higher casualty expenses primarily due to a lower personal injury actuarial credit than we booked a year ago.

Sequentially, our incremental margins were slightly above 50%. And for the year, we continue to believe incremental margin will be 40% plus.

Interest expense declined 23% to $32 million as a result of our debt reduction and refinancing activities over the last year and a half. Since the start of our debt restructuring, we have reduced interest expense by $13 million per quarter or more than $50 million annually from 2009 peak quarterly levels.

During the quarter, we did incur $10 million in debt retirement costs. Those are the result of our refinancing that we completed in May for KCSM.

Moving to our tax rate, our effective rate was 37% consistent with the guidance we’ve been providing this year. And for the full year, we’ll continue to believe we’ll be in that 35% to 37% range.

Finally, adjusted earnings per share were $.71 up 29% from last year; the best reported EPS growth rate to date for the class ones. Our share count did increase $9.4 million. That reflects the conversion of the preferred shares to common during the first quarter of this year. And then the full quarterly impact of the secondary equity offering we completed a year ago during the second quarter.

Moving to Slide 26, operating expenses increased 15% led by a 33% increase in fuel. The left side of the chart, you can see detail line item expense changes on a year-over-year basis. And on the right side of the chart, we have provided a categorization of key drivers behind our expense increases. During the quarter on a year-over-year basis, we saw approximately $19 million in volume related cost increases. $14 million in fuel price increases. Most of that would be recovered in future periods through our fuel surcharge.

We showed increased casualty expense resulting from lower PI credits that we booked in 2010. And then finally, changing FX rate, it is important to note that while expenses were up $6 million due to FX, revenues were higher by approximately $7 million from FX. So we actually had a slightly positive impact to operating income.

And again, we would expect higher incremental margins in the back half of the year versus the second quarter. And expect higher volume growth compared to expense growth.

Moving to Slide 27, you can see our employee headcount increased slightly. But still remains very much under control as we continue to improve employee productivity that Dave discussed earlier with a 6% increase in carloads per employee.

Our increases in comp and benefits are largely due to inflationary wage and benefits increases along with increases in carload volumes. And to a lesser degree, FX.

On Slide 28, again our fuel went up 33% year-over-year largely due to fuel price increases. And to a lesser extent, volume and FX.

On the right side of the slide is a chart that illustrates the $2.5 million negative fuel lag costs, which negatively impacted OR by about 50 basis points. And EPS by about a penny and a half. And for those of you who are interested in the average price per gallon, it was $2.87 for the quarter on 32.3 million gallons.

Moving to Slide 29, our liquidity at June 30 increased to $381 million. That includes $156 million of cash. Year-to-date, we have generated $92 million in free cash flow, which is a 32% increase over 2010.

And then subsequent to quarter end, we did renegotiate our U.S. revolving credit facility and further improved our liquidity by increasing the capacity by $75 million from $125 million to $200 million. The other major point, we extended the maturity of our term loans moving those out from 2013 to 2017. And also achieved more financial flexibility to paid dividends and buy back stock and/or debt in the future.

And then lastly, as it relates to liquidity, we are currently exploring an amendment to our Mexican credit facility for KCSM to further bolster the liquidity profile.

Moving to Slide 30, we’ve made significant progress extending and smoothing maturities. As most of you know, we’ve been focused on improving our capital structure over the past few years. And have reduced overall debt balances by $450 million.

At December 31st, 2009, as Dave mentioned earlier, we had approximately $1.1 billion of our debt due in an 18 month window in 2012 and 13. And along with some of the prior refinancing activity, we did refinance our 7 3/8 and 7 5/8 notes with a 6 1/8 tenure note. That was at the KCSM level.

We did that in May. And then with the renegotiation of our U.S. term loans that we just completed in the last two weeks, we’re now focused on using existing cash balances to fully retire by year end the 13% note in the U.S. that are due in 2013. So we’ll pay those off early. And that would result in a very, very manageable maturity profile for us. As Dave noted, no debt due until 2015. And very much a smoothing of our maturities.

And then finally on Slide 31, I wanted to spend a few minutes discussing the impact of our Hurricane Alex insurance settlement. We did announce that in a press release in an 8-K that on July 7th, we settled the property and casualty portion of the claim for $66 million subject to a $10 million self-insured retention or deductible. We previously had recorded or received interim advances of $40 million. We now expect to receive the final $16 million tomorrow.

The settlement will result in a $19.8 million gain that we’ll record in the third quarter financial statements. And that will be reported as a separate line item as a contra to operating expenses. So you’ll have clear visibility to that non-recurring gain.

The general liability portion of our claim is $7.6 million. It is still outstanding, but we do expect to settle that this quarter. In the third quarter to date, we’ve received an advance of about $3 million on that claim. And we’ll wrap that up here in probably the next month or two, certainly before we report third quarter earnings.

So as we look over the last year, all the activity related to this hurricane, we do expect the negative impact to be about $.05 per share, which is consistent with the guidance we provided you a year ago during our second quarter 2010 earnings call.

And with that, I’ll turn the call back to Dave.

Dave Starling

Okay Mike, thanks. In summary, KCS has a very good second quarter. We’re well positioned for a strong third quarter and second half. Operating efficiency remains excellent. Pricing is solid. Expenses are firmly under control. And as Mike I’m sure has pointed out, we expect our incremental margins to improve in the third and fourth quarters. And end the year somewhere in the 40% to 50% range.

And finally as I noted up front, we expect our full year revenues will come in with a percent increase greater than the 14% we achieved in the first half. Our confidence comes from the anticipation of solid revenue growth in all our business groups, the continued expansion of our cross border business, and the fact the Mexican economy is currently growing at a rate roughly twice that of the U.S. Put it all together, and there’s no question we’re looking forward to the rest of 2011.

With that, we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Bill Green from morgan Stanley Smith Barney.

Bill Green – Morgan Stanley Smith Barney

Yeah. Hi. Good afternoon. Just for a point of clarification, Dave, on your last comments. Obviously, given the improvement in the [inaudible] margins, is it safe to say that operating ratio improved [inaudible] 150 – I’m sorry, 100 to 150 so far this year. You should be much better than this 110 basis points that we’ve gotten even in the first half given the revenue outlook and the improvement in incremental from here. Is that safe to say?

Dave Starling

You know, we hope we’re going to do better, Bill, but we’re still sticking with our guidance of the 1 to 1 ½ points. We’re certainly, this quarter, the third quarter is going to be a little harder to compare to the [inaudible]. But we certainly are going to continue to improve.

Bill Green – Morgan Stanley Smith Barney

Okay. So when we look at headcount and you guys have kept it really sort of flat for quite some time now, some of the other rails have started adding. If I look through sort of the headcount [inaudible] if you will, [inaudible] start hiring given these growth rates. How should we be thinking about kind of where we are in the productivity story? Are we sort of seventh inning or how do we think about where we are?

Michael Haverty

I’ll let Dave answer that.

Dave Starling

Okay. Our headcount continued to remain relatively flat as we continue on the current growth trend and we leverage our latent capacity that we have in Mexico. In the U.S., we continue to scale below the growth and will continue to do that. We figure we still have about 8% capacity left to grow on the Mexican side.

So we’ll continue the current productivity trends and we’ll scale lower.

Michael Haverty

And you know, one other comment, Bill, there’s more than T&E headcount. So we’re continually looking at our administrative costs in all the other department as well.

Bill Green – Morgan Stanley Smith Barney

Okay. Just one last question on autos. Longer term, how – I don’t know how to think about what the real sort of opportunities that are there. Is there a way to sort of say, well, look, this is the addressable market that we think we can have access to if we can win some of it? Because there growth rates are just huge and off the charts, and I’m not sure how think about [inaudible] to slow them down?

Michael Haverty

Bill, I think that, you know, as the industry has kind of really ramped up, we still see opportunities for market share at some of the plants that we serve. There’s still plants that we could serve in Mexico that we can’t, or that we don’t currently. And then there’s the impact of the longer-term new plants that are coming online.

I think, you know, this growth rate level for the next few quarters is likely to flatten because of the fact that the industry has bounced back so much. But we will still see exceptional growth in Mexico and in longer term, the outlook is very good.

Bill Green – Morgan Stanley Smith Barney

Okay. Thanks for the time.

Operator

Thank you. Our next question comes from Allison Landry from Credit Suisse.

Allison Landry – Credit Suisse

Thanks. Good afternoon. I was wondering if you could provide a little bit of color on the current average length of haul is and maybe how that compares to historical trends?

Dave Starling

This is Dave. You know, currently we’re trying to build our Intermodal product. So as we have added the new training starts out of Mexico, it is definitely pulled down the length of the train of debt. But that’s an opportunity for us to fill those trains out, so it’s not as critical as measurement to us today.

Are you talking length of haul, or length of train?

Allison Landry – Credit Suisse

Length of haul.

Dave Starling

Oh, okay. Well, the length of haul will still be a factor of the Cross Border traffic. And that number is improving in this quarter. And we also are getting the longer haul coal traffic as Pat referred to. So we will continue to increase the length of haul.

Allison Landry – Credit Suisse

Okay. And then as a follow up on the Cross Border Intermodal capacity, how should we think about durability to handle the additional volume growth you’re expecting over the next few years in terms of how much capacity you think that you have there, and should we expect any incremental of CapEx for infrastructure or rolling stock?

Michael Haverty

Well, let me take the terminal question first, and then I’ll turn it over to Dave for the train operation. You know in the last three years, we have spent close to $300 million in the Victoria Rosenburg line, a facility that we built at CIT Houston in [inaudible]. We have doubled the size of our Intermodal facility at Monterey. We are in the process of purchasing the facility in San Louis [inaudible]. And in the month of June, we completed tripling the size of the facility in Port of Mexico.

So from an Intermodal capacity standpoint, we are in good shape for three to five years on Intermodal growth. In fact, I’d like to be challenged to say we didn’t have enough capacity and had to build more. But we certainly are ready for this Intermodal conversion.

Dave Starling

And I’ll also add there that we’ve got a line capacity of infrastructure of about 200,000 cars per month right now. And we’re well below that, running at about 166,000 for the quarter. We continued with the investment through the line that Dave talked about, and we do not see any capacity constraints in any of the near future.

Allison Landry – Credit Suisse

Great. Thank you very much.

Operator

Thank you. Our next question comes from Jason Seidl from Dahlman, Rose and Company.

Jason Seidl – Dahlman Rose and Company

Hey, guys. Good evening. How’s everything?

Michael Haverty

Hi, Jason.

Jason Seidl – Dahlman Rose and Company

A couple quick questions. One on the pricing side. I know you gave guidance in sort of mid-single digit range, but with, you know, 5.5 in the recent quarter and 6 in your factual goals and having such a decent amount renewed, shouldn’t we expect to see probably a little bit better than 5.5 in 3Q or am I looking at that wrong?

Michael Haverty

Yeah. I think – if you remember, the first quarter, Jason, we – on contract renewals, we were actually up a little over 7. So you know, we’re going to begin – now, that’s not – that’s not necessarily on all same store basis. So when I say, you know, 6% for contract renewals, that’s not necessarily going to equate exactly to 6% same store because in some cases when we renew these large contracts with multiple lanes, the pricing is different lane by lane based on competition, based on equipment issues, and other things. So when we – it’s not necessarily the case that that 6% is going to feed a same-store sales. It’s certainly going to help.

You know, I think the environment we’re in feels like it’s going to be pretty strong, and you know, shippers are interested in locking in capacity, base capacity to make sure that they have the capacity when, you know, to prevent against equipment tightness if that were to happen. And we’re still seeing not just in the Intermodal, and the Cross Border, but we’re still seeing opportunities to gain market share versus truck at paper plants and steel plants, appliance plants. And you know, I think that’s going to equate to some pretty good pricing moves.

Jason Seidl – Dahlman Rose and Company

It doesn’t sound like you guys are have much trouble getting business off the road there? Can I look out a few years now, we talked a little bit about the Phase 2 of Lazaro Cardenas being awarded before the end of the year. Let’s say it is awarded. How long before we see that capacity builds and, you know, containers flowing through it on your lines?

Michael Haverty

It’s really hard to tell because we don’t know the rules of the bid. If you look back on what happened historically, you know, I think before any material volume comes through a new terminal it’s going to be at least a year. And we would expect that the bid and the award would contain some commitments and deadlines. That’s what happened in the case of the first terminal where as a condition of the award, they have to complete certain activities and generate traffic within a certain timeframe.

We don’t know what those rules are until we know – and actually, Dave was down there a few weeks ago, in Lazaro meeting with the Port Authority. So you might have…

Dave Starling

Yeah. That closed in – the bids actually closed the day I was there, and they said they had solid bids. They were moving forward. It’s either 12 or 24 months that they have to have a port completed, [inaudible] in place, and open for business after the award. So it’s within a one to two-year timeframe. I’m not exactly sure, but there is definitely a timeframe involved with the awarding of the bid.

Hutchinson has started their second phase. We actually went down and kicked the tires and they should have that opened by the end of this year. So the capacity is definitely going to be there.

Jason Seidl – Dahlman Rose and Company

So we’re looking, at best, sometime in 2013 [inaudible] or 2014 for the new phase?

Dave Starling

For the second…

Jason Seidl – Dahlman Rose and Company

For the second phase.

Michael Haverty

Yeah, but we’re not restricted right now. I mean, the Hutchinson facility will open at the end of this year, so that definitely gives us the opportunity for new business and to add more carriers to Lazaro.

The thing we think the second port concession will do is offer the carriers more competitive rates and could accelerate because of the movement of ships, carriers calling [inaudible] over the Lazaro Cardenas.

Jason Seidl – Dahlman Rose and Company

Interesting. Guys, I appreciate the good color.

Operator

Thank you. Our next question comes from Scott Group from Wolfe, Trahan and Company.

Scott Group – Wolfe, Trahan & Company

Thanks. Good afternoon, guys.

Michael Haverty

Hi, Scott.

Scott Group – Wolfe, Trahan & Company

Just a couple quick things to clarify. The revenue growth accelerating better than 14% in the second half, is that excluding these easy comps with Alex? That’s one part of it. And then the second part, can you just – I’m having trouble understanding – on Slide 16 you talk about a $14 million increase in revenue from same store pricing. And then the next slide you talk about a 5.4% increase in same store pricing. Those don’t seem to match up. If you can just give a little color there.

Dave Starling

Fourteen, okay. Yeah, the $14 million in same store pricing, that applies to 270 – roughly 270. You’ve got to get into the real numbers and get out of the rounding. You know, if you take 14 over 270, you’ll get something like 5.3. But when you actually use the real numbers, it doesn’t work out to 5.4.

Michael Upchurch

Scott, this is Mike Upchruch. With respect to your other question, obviously the third quarter’s relatively easy comp for us given the impact that we reported a year ago for Hurricaine Alex. But I think you’ll see that even pulling that out, we would expect revenue growth to accelerate.

Scott Group – Wolfe, Trahan & Company

Okay, and that’s great. And just the other question, again, outside of third quarter easy comp, why is it that incremental margins are going to get better going forward from here? Is something changing on the cost side? Is it just you’ve got a visibility of the revenue growth accelerating? What’s driving the confident that incremental margins get better from there?

Michael Upchruch

Yeah, Scott, Mike again. I think probably two things. As I indicated in my comments, second quarter is typically when we see some credit for personal injury for our actuarial study, and year over year we had a lower credit that we booked in the second quarter of about $5 million. And then, you know, certainly the fuel comps have been much more difficult in the first half of the year. And I'm not going to try to predict what is going to happen with fuel prices. But you know, even if we were flat or, you know, picked some of that up along with the PI, you know, we believe that we should have better incremental margins than what we reported in the second quarter.

Scott Group – Wolfe, Trahan & Company

Okay, that’s helpful. Thanks for the time.

Operator

Thank you. Our next question comes from Matt Troy from Cisco Hanna International Group.

Matt Troy – Cisco Hanna International Group

Yeah, thanks. I have a question on export coal. I think we’ve seen recently three proposals. One at [inaudible], Port of Corpus Christi, and Port of Houston. I was just wondering have you been in conversations, or have you been approached about servicing or coordinating with any of the players out of the three ports? I know you access Corpus Christi directly, but [inaudible] accesses directly as well. You’ve gotten the Burnside, which is kind of the TDB. I was just wondering if you’ve been having conversations about export coal opportunities growing to the golf as the infrastructure grows?

Michael Haverty

The one export coal opportunity that we have been pursuing is actually at Lazaro Cardenas. That’s the TPP facility at Lazaro, which is going to come online I think in the second quarter of next year. And it’s hard to tell.

That’s obviously a fairly long haul from say Central Illinois. I think the draw of Lazaro is going to be Illinois Basin, you know, Illinois, Indiana, Kentucky coal, which wants to move to Asia, and has a lot of challenges getting there because it’s tough to get to the West Coast. And going to the East Coast, you have an awfully long voyage to get to North China. So there is interest on the part of the terminal operator. There’s interest in part of the coal producers. And there’s enough interest that we are spending a fair amount of time trying to drive that to an outcome, which would lead to coal being exported out of Lazaro Cardenas. But at this point, it’s still too early to tell when, and how much, and what that might amount to.

Dave Starling

This is Dave. I might add we certainly don’t have it built in our plans, but it’s a nice long haul. And we’d love to have it.

Matt Troy – Cisco Hanna International Group

Okay, so the three potentially new facilities though, you are not in discussions. You’re staying the course with your original bet and focus.

Dave Starling

No, we have talked to Corpus, the port of Corpus Christie about their plans. But again, it’s too early to know what they’re actually going to do. And as you mentioned, we conserve that port, so it’s to get to North Asia from Corpus is obviously a very long sales. When you put the – and it’s just a matter of putting the total package together and what makes the most economic sense. And capacity, as you know for export coal, is constrained off the west coast anywhere. And there’s enough coal that wants to move there and China seems to want to buy it all, there might be enough for everybody. And then Lazaro Cardenas, you’re on the right side of the canal.

Matt Troy – Cisco Hanna International Group

Second question, would this be a metric and intermodal volumes if I look at the AR reported data? You’ve kind of buffed the trend that you’ve seen that the U.S. railroads specifically if I look at your first and second quarter volume growth in intermodal in the 22%, 25% range over the last four weeks, it looks like you’re up at almost twice that level on a going-forward basis. I was just wondering if that Victoria line, what’s going on there that you’re seeing the recent strength? Is it just going to be a year-over-year comp easier for the last year? Any color on that would be helpful. Thank you.

Dave Starling

It’s really a combination of all those things, but it is also a big factor is the easier comps because July of last year, we were out of service between Laredo and Monterey. And that affected our intermodal business pretty strongly.

Matt Troy – Cisco Hanna International Group

Right, okay, thank you very much.

Dave Starling

That’s certainly not all of it. We’re seeing growth in Lazaro, growth in cross border, growth in the other intermodal business within Mexico.

Operator

Thank you, our next question comes from Scott [Notts] from Goldman Sachs.

Scott [Notts] – Goldman Sachs

Hi, thanks. First on the intermodal, the same store sales, I understand you want to build density. One thing, if you can help us think this through a little bit more that with fuel prices high and truck load prices rising, you seem to be trying to make even a sharper of a price difference between rail and truckload competitors. Can you talk about what the average range of how much lower you are versus your truckload competitors on pricing for intermodal. And kind of why you really need to push price this much.

Dave Starling

There’s some of it is a function of, as I said in my comment, getting the traffic, getting the business on the train and keeping it there. And certainly in terms of some of the recent conversions, we feel that holding some price for some period of time, and focusing on building density, and improving contribution and profitability by increasing the length of those trains has a very powerful bottom line impact for us. And will help us secure that business for a longer period of time.

Scott [Notts] – Goldman Sachs

So what is the relative price? Is there any way you can give like some kind of average relative price difference for a customer on a cross border move or just your intermodal business versus the truck?

Dave Starling

Not really. What I will say is that generally, the paradigm for thinking about truck versus rail or rail versus truck is in Mexico, is not too dissimilar from in the U.S. The one added piece that we have to offer is the cross border cost in transit time savings. So I’ll just step back and say all the ingredients are there for us to go after this market. And I think the cross border thesis is very similar to the long haul in a rail versus truck advantage in the United States.

Scott [Notts] – Goldman Sachs

Okay, thanks. The other thing I have is just on, you talked a bit about developing the Port Arthur terminal. Can you just talk about the opportunity in crude oil? How much are you moving right now and what’s the opportunity there?

Dave Starling

We’re moving zero right now because the terminal doesn’t exist, but I think the opportunity is substantial. We’re working with Savage, a private company. We announced a partnership with them a few weeks ago, maybe a month ago now. And Savage is building – they’re a company we know, they’re in the rail services business. They operate a terminal for us at Port Arthur, which is an export loading facility for petroleum coke coming out of the refineries around Port Arthur.

So they know the market and they’re a partner that we trust and believe that they can make this happen. But what we’re doing now is out trying to secure indications of interest and commitments for volumes. And we have some thresholds that we have in mind, and once we get those thresholds, the Savage will build the terminal at Port Arthur. They are under construction and building a terminal up in North Dakota in the Baken Region. So they’re looking at a total logistics package, which would include origin terminal facility in North Dakota, destination terminal facility in Port Arthur, and then we would work with other carriers to provide the rail transportation.

It’s a big market. Port Arthur imports over a million barrels of crude oil a day, and – so it’s a market that’s looking for new sources, and we think this could be a significant opportunity for us. And our Port Arthur facility is in the middle of the refining companies that are in Port Arthur. A lot of these would literally be a pipeline away. The property is even continuous in some cases.

It’s 500 acres, and it has a good waterfront access as well. So it’s a very attractive piece of property for this type of a project.

Scott [Notts] – Goldman Sachs

Thanks, very helpful.

Operator

Thank you. Our next question comes from Tom [Waveless] from [Inaudible].

Tom [Waveless]

Yeah, good afternoon. I wanted to ask you a little bit on Intermodal. I typically don’t think of your intermodal business, or your Mexico business as having that much competition. There’s just so much difference in your out structure versus [inaudible]. But I think Pacer announced something during the quarter, a service with [inaudible], and I believe it was auto-related traffic. That appeared like it might be moving over to Theromax from you. I wondered if you had any kind of comment on that specific weight in, just kind of the broader thought of, you know, is Theromax a material competitor when you think about cross border intermodal, or are they really, you know, they just don’t have the right route structure in general?

Michael Haverty

That’s a tough one, Tom. Yes, yes, and yes. You know, I think that, you know, all we’ll say is that we have an outstanding intermodal network cross border. As Dave mentioned, we’ve invested close to $300 million in line capacity terminal capacity. We have a state-of-the-art world-class, and Dave Starling knows that that means. He’s probably built and operated more intermodal terminals than anyone in the business in his career.

So we, you know, the network is in place, and we feel in our partnerships, our channel partners are very engaged. So – and it’s a big market. So we – we think everything is in place for us to have some just outstanding performance there.

I think the business that you’re referring to, and we’ve heard mixed signals on this, is actually to a location in Guadalajara, which is not where we have a national advantage for cross border traffic. So if it goes that way, you know, I think we can look at it and kind of say that it’s difficult for us to serve Guadalajara because we don’t have direct access for cross border intermodal. And that’s one market that we might have some, you know, might not have the strongest position regarding the other railroad.

But I might add that we have no problem at all in competing in Mexico on transit service.

Tom [Waveless]

Right. Well, okay, that was my assumption that, you know, the franchise matters a lot and you invested a tremendous amount it. So okay, so that’s kind of small noise and it’s more related to that specific geography in Mexico.

Let’s see, in terms of the – let’s see, the weather impact, I suppose – no, I guess there’s enough noise in the volumes here. Was there much of a, you know, a coal impact, enough to kind of [inaudible] for us and how much that might boost your coal volumes in second half related to your connecting business with BN and UP? Obviously BN’s coal volumes are down pretty sharp over the last several weeks, and I think UPs were a little weak.

Any thoughts on that?

Dave Starling

This is Dave. I’ll take that one. I mean, everybody knows we connect with BN and UP in Kansas City and that’s where the coal comes from the plants. And they definitely had problems. We had worked with them and tried to mitigate them, but it has slowed down cycle times. So fortunately coal plants generally have about a 60-day coal burn on the ground, so they’re burning through that and once we get the weather corrected and we get everything back on cycle, we’ll have the opportunity to refill those stockpiles. And at the same time, I don’t want to take – cause anyone to be fretful about the heat, but it’s a good thing for us. They burn a lot of coal. So we, along with our friends to the north, think that there’s going to be a surge. We don’t know how much of it there will be, but there will be a lot of coal burned and reasons to replenish those stockpiles.

Tom [Waveless]

Do you think that’s kind of a quick thing, or that’s more into fourth quarter when you see [inaudible]?

Dave Starling

Oh, I think it’s going to be throughout the second half of the year. And I think we’ve really covered that in our guidance on the double-digit growth for coal in second half.

Tom [Waveless]

Right, right, okay. Thank you for the time. I appreciate it.

Operator

Thank you. Our next question comes from the line of Ken Hoexter form Vilanch.

Ken Hoexter – Vilanch

Great. Good afternoon. If I could just stick on the coal for a second. Pat talked about some of the coal lanes were extended and that’s going to impact yields in the next quarter. Can you delve into that a little bit? What is shifting there that’s going to impact the yields in the quarter?

Michael Haverty

It’s really just a timing thing, Ken. It just so happens because of maintenance schedules and other things that were going on in the quarter, a higher percentage of our movements in the second quarter were going to our longer haul utilities. And so I don’t expect that you’ll see the same sort of RPU growth. But you know, with the flooding and the service disruptions, and people scrambling around to make sure that they keep their stockpiles at adequate levels, we’re not certain how that’s all going to play out in terms of the destination. Because, you know, we serve several plants and some that are multiple utilities. And they make choices from time to time whether to send it to Plant A or Plant B. And depending on whether they give us the long haul moves or the short haul moves, it’s going to affect our revenue per unit.

Ken Hoexter – Vilanch

All right. But I mean overall as you work through the year it’s kind of neutralized?

Michael Haverty

It is. It will. It will work itself out over the course of the next few months.

Ken Hoexter – Vilanch

I’m sorry. I’m a little confused by that. So you’re not consistently sending to each one of the utilities? You’re actually switching which plants – so it’s not a constant cycle to each one of the utilities?

Michael Haverty

On any given quarter, that is true.

Ken Hoexter – Vilanch

Okay.

Michael Haverty

However, over the course of the full year, it’s going to level out.

Ken Hoexter – Vilanch

Yeah. Okay.

Michael Haverty

So the plants themselves are actually making that diversion. That’s one of the advantages they have with KCS. Once it gets on our system, if they want to switch it to another plant because they’ve got maintenance or they need to build a stockpile in that plant, they can actually switch it, even in transit.

Ken Hoexter – Vilanch

Okay.

Michael Haverty

But again, at the end of the day, this is not a seismic shift. This will all level out and we think the coal numbers will be as originally advertised. And then you may see a plus because of the heat and just the coal burn in the plants. And that’s why give them the double digit guidance in the second half.

Ken Hoexter – Vilanch

Great. Thanks for that. And then if you think about your incremental margin commentary, which you’ve hit up a lot. If we think a little bit longer term, I think Dave talked earlier about keeping the personal cost and having that capacity particularly down in Mexico. Can you maybe talk a little bit about some other leverage points that you have? I don’t know whether it’s the equipment availability or purchase services, where else you have [inaudible] leverage to I guess move the operating ratio into the – like you have right now, so the upper 60s as you’re somewhat near term [inaudible]. Can you talk about what other options you have out there?

Michael Haverty

Sure, Ken. As we continue to grow, you know, we’ll continue to see operating expenses scale lower than the revenue growth. And you know, again, they’ll be the occasional [inaudible] if we put on new train starts, but that will be for a short duration. The largest cost savings efforts will center around leveraging our basic existing headcount and maximizing optimization of it for productivity. It will also be rationalized in our rolling stock equipment leases. We’ll be renewing maintenance contracts, especially in Mexico, and looking to rationalize those. And then a lot around our fuel conservation efforts, as those prices continue to increase, we’ll pay more and more dividends.

And I might add what we’ve talked about in the past. We still have latent headcount capacity in Mexico that we still have a lot of trains we can add before we have to start hiring down there. So that’s probably our biggest opportunity right now is to continue to add volume.

Ken Hoexter – Vilanch

Is there a timeframe on some of those leases or the maintenances contracts? Is there a timeframe coming up, you know, in the second half of ’11 or early ’12 for some of those?

Dave Starling

Right now, it will be the second half of ’11 that we’ll be renegotiating two of our maintenance contracts.

Ken Hoexter – Vilanch

Thanks for the time. I appreciate it.

Operator

Thank you. Our next question comes from Anthony Gallo from Wells Fargo.

Anthony Gallo – Wells Fargo

Thank you. Cross border intermodal question. Does the network have [inaudible] off balance right now, or how is that playing out right now?

Dave Starling

It does. On our cross border network – are you talking about intermodal?

Anthony Gallo – Wells Fargo

Yes.

Dave Starling

It’s very close to 50/50, a little bit more northbound. But it’s well balanced. And if you look at the total market data that we’ve – I think we shared in the June 29th presentation on the market, the truck market, it’s actually pretty well balanced as well.

Anthony Gallo – Wells Fargo

The growth and near sourcing that you talked about [inaudible] was very helpful. Is that containerized good as well? Does that facilitate more [inaudible] or are they two separate items really?

Dave Starling

I think it will be both. I mean, we’re seeing more and more interest on the part of companies that have traditionally or, you know, for the last several years, maybe decades have not used rail as in boxcar. You know, I won’t name any of the companies, but we’re seeing more interest in companies that adding rail, as in boxcar rail to their mix, and their kind of base logistics planning in addition to intermodal and over the road. So I think this general near-sourcing phenomenon, the growth and industrial activity in Mexico will possibly feed multiple business unit. Intermodal will probably be the fastest. But we see opportunities working with customers now doing test loads, companies in Mexico that are 100% rail – or intermodal or over the road, that are more and more interested in introducing boxcars.

Anthony Gallo – Wells Fargo

And then a separate question, unrelated. [Inaudible] I’m not clear on what might be happen in Mexico, but what’s the outlook over the next year or so for wage and benefit growth?

Michael Haverty

Just specifically Mexico, or both?

Anthony Gallo – Wells Fargo

Both if you can.

Dave Starling

There’s a tentative agreement being negotiated right now in the U.S. and that currently projects it at 17% over five years. But that hasn’t been ratified yet. That will go out for an August 5th vote, and we should know back whether it’s ratified by September 6th.

And in Mexico, we are looking at negotiations ongoing right now and those negotiations of the rate will keep up with inflation.

Michael Haverty

Generally, Mexico is an annual basis. A little bit of inflation plus, and in the U.S. , we’re in the same agreement process that the other railroads are in.

Anthony Gallo – Wells Fargo

Those 3 to 4% annual numbers, they’re pretty consistent with what you’ve been accruing and what the other the railroads are talking about. Is that fair?

Michael Haverty

In the U.S., definitely. And in Mexico, that’s close range.

Anthony Gallo – Wells Fargo

Thank you, gentlemen.

Operator

Thank you. Our next question comes from Scott Nichols from Joseph, Rosen and Company.

Scott Nichols – Joseph, Rosen and Co.

Congratulations on a great quarter. David, I’d like to ask you, in your opening remarks, you said essentially that you don’t have any debt repayments due until 2015. Is that because of this recent pack agreement?

Dave Starling

I’m going to like Mike answer that one. He can give you more details.

Michael Upchurch

This is Mike Upchurch. We do have a 13% note in the U.S. that’s due 2013. But as I described in my talking points, we do have plans to call that before the end of the year. And we showed you the pro forma maturity schedule, assuming we call that, retire it with cash, we would not have any maturities due until 2015.

Scott Nichols – Joseph, Rosen and Co.

In your 10-K, it showed that for 2013 you’ve got debt due of 458 million.

Michael Upchurch

And that included the term loans that we just announced two weeks ago that we had pushed out to 2017. So that’s done.

Scott Nichols – Joseph, Rosen and Co.

That’s done. So you won’t have any debt coming due until 2015?

Michael Upchurch

Correct. After the ‘13s are retired.

Scott Nichols – Joseph, Rosen and Co.

After the ‘13s are retired. Now, the ‘13s are going to cost you how much? Is there a penalty?

Michael Upchurch

At par plus coupon.

Scott Nichols – Joseph, Rosen and Co.

So what will that come to, 139 million?

Michael Upchurch

You’re pretty darn close.

Scott Nichols – Joseph, Rosen and Co.

Close. And you expect to do that in December?

Michael Upchurch

Yes. That’s our plan today.

Scott Nichols – Joseph, Rosen and Co.

Okay. Thank you very much. That’s all we have.

Michael Upchurch

Thank you.

Operator

Thank you. Our next question comes from Keith Shoemaker from Morningstar.

Keith Shoemaker – Morningstar

Thanks. I’ll ask about use of cash. [Inaudible] a history of consistent positive free cash flows pretty short. Could we get an update on the CapEx budget? Is it still north of 20% of sales for 2011?

Michael Upchurch

Yeah. This is Mike Upchurch. I think on our last quarterly call, we talked about roughly 22%. We’re still in that range today. That was a step up from what we had provided at the beginning of the year, but that’s primarily because of two issue. One, acceleration of locomotives that we had in our plans for 2012. We accelerated that to take advantage of the tax benefits. And then we are contemplating the completion of a couple of lease buy-outs here in the third quarter that would represented some incremental cash CapEx. It will take us in that 22-ish range.

Keith Shoemaker – Morningstar

Still 22 then? And in light of the reduction of preferred dividend obligations, completion of several major capital projects lately, could you please comment on your [inaudible] towards your use of cash? Is there a certain threshold at which you would consider.

Michael Haverty

Well, you know, our priority is always going to be around investing in our business and making sure we, you know, continue to grow to trajectory that you’ve seen us deliver over the last couple years. But even if you play that out over the next few years with the cash production, you know, debt payments being very minimal, it does create a situation that, you know, we have discussed publically before, of potentially evaluating a return to shareholders. But we’ve made no firm decisions on that, and I think as we’ve discussed previously, that’s a 2012 decision for us.

Keith Shoemaker – Morningstar

Thank you.

Operator

Thank you. Our next question comes from Christian Wetherbee from Citigroup

Seth Lowery - Citigroup

Hi. This is Seth Lowery in for Chris. I just have a quick one on the cross border intermodal. If we were to just conceptionally think about freezing pricing at the current level, could you give us a sense, just in general, how much freight would still inevitably come onto your network?

Dave Starling

No, I can’t – I can’t really – we haven’t specifically given guidance and growth targets for just the cross border But I’d just go back to something, we’re not freezing prices. We’re not freezing rates. When we bring a new customer on, we do it in a way that, you know, may involve some commitment or some period for pricing to be constant. But you know, our focus is to – is to grow the market share and improve the utilization of the trains that we’re running and improve profitability, and keep the business that we’ve had, that we’ve gotten. So you know, we’ve talked about how big the market is. We’ve talked about where we are in terms of market share. The facilities being in place, and the fact that the intermodal truck to rail conversion thesis is very strong, particularly given the time and the cost of dealing with the border crossing on an over-the-road move.

So we think we can get to a very good level of – get very good market share over the next few years, and you’ll continue to see very rapid growth.

Christian Wetherbee - Citigroup

Okay. And you know, I – I guess in reference to your previous target, I think, you know, you put out the [inaudible] prior presentations the million truck load market and the 1% penetration of that market. Is that fair to say that we’re a little ahead of that, or can you give us an update on that?

Dave Starling

At this moment in time, that’s really about where we are.

Christian Wetherbee - Citigroup

Okay.

Dave Starling

That’s still a very current testament. We’re just getting started.

Christian Wetherbee - Citigroup

Okay. Thank you.

Operator.

Thank you. Our next question comes from Brad Belco from Stephens, Inc.

[Brad Belco] – Stephens, Inc.

Good afternoon, gentlemen. How are you?

Dave Starling

Okay, Brad.

[Brad Belco] – Stephens, Inc.

Well, most of the questions have been asked, but I’ll give it a shot. Dave, I think last quarter you talked about the opportunity on some of these leases, and I heard it mentioned the last several times. And I think you said it was an opportunity to improve the OR by about a ½ of basis point. And it seems like that continues to be the plan towards the back half of the year. Would you say that your OR guidance of, you know, 100 to 150 includes taking advantage of some of those opportunities, or would that be viewed as something incremental?

Dave Starling

In that case, it would. But we are also, you know just back to the question of Mike Upchurch about the uses of free cash flow going forward, we are certainly going to be evaluating all of our leases. As we have fixed our balance sheet, it may make sense to own instead of lease. So we will be going through that process over the next 12 to 18 months and we may be able to continue improving our OR on that conversion as well. But that has not been factored into our longer range guidance of 1 to 1 ½ points.

Michael Upchurch

Brad, just to be clear, that guidance that we gave last quarter was 40 basis points annualized.

[Brad Belco] – Stephens, Inc.

And I guess last, you know, several of the people we’ve talked to seem to be pretty excited about the Mexican intermodal opportunity. Do you care to comment in terms of, you know, maybe what particular carriers that seem to be expressing more interest, or what any of the pushback would be?

Dave Starling

You know, it’s kind of funny. We started with the container guys, the truckload carriers that have their own assets. And now we actually have the TOFC truckers that understand that if they don’t start the rail conversion, the guys with containers are going to steal their business. So we’ve got everyone talking to us now, anyone that’s doing business in Mexico and sees the opportunity. The near sourcing phenomenon, there’s so much press on it that people are coming to us to talk about it now. And we really see a combination of containers, truckload carriers, the siders, the hops. We also see a combination of truckload carriers that use intermodal and even potential of container boxes, container fleet that we would be able to bring even more of the INCs on board.

So I don’t think that any of the [inaudible] channels are fully closed.

[Brad Belco] – Stephens, Inc.

I appreciate it, guys. That’s all I had. Congrats on a good quarter.

Dave Starling

Thanks, Brad.

Operator

And our next question comes from Art Hatfield from Morgan Keegan.

Art Hatfield – Morgan Keegan

Good afternoon, guys. I wanted to come out of the intermodal opportunity from a different perspective. I think last year about this time you guys noted intermodal potentially going to over 20% of your overall revenue base for the next three-plus years. So you know, just kind of as you look at the business a year later, you know, have things kind of progressed as quickly as you’d like on that front? And really, is that 20% plus as a portion of your overall revenue base, is that kind of seal the goal – the target goal for the next three to four years?

Dave Starling

Yeah. I think we can, you know, with the growth rates we’re showing and the opportunity that’s there, I think we still feel that we’ve got the ability to get into that range.

I think you’ve got to understand too, we’re growing intra Mexico, we’re growing on the Radian Speed Way. We’re growing on the Cross Border Domestic coming out of Mexico. And we also still have the opportunity for the international coming through Lazaro for the Houston market. So it’s not just one market we’re looking at.

Art Hatfield – Morgan Keegan

Yeah, absolutely. And then on the CapEx, I’m not sure if you guys mentioned it, but are you guys still targeting 475 million for this year?

Michael Upchurch

It will be a little bit higher than that, but still in that 22% of revenue range.

Art Hatfield – Morgan Keegan

Okay. Are you guys pulling any additional purchases for it this year other than your locomotives, or is that just kind of your normal increase to CapEx?

Michael Upchurch

There’s nothing significant that we’re pulling forward. There could be some containers that we may purchase by the end of the year, but nothing significant.

Dave Starling

And I might add, you know. we pull this forward for a tax reason.

Art Hatfield – Morgan Keegan

Yes, absolutely. Thanks a lot for the help, guys.

Dave Starling

Okay. Thank you.

Operator

Thank you. We have time for one last question. And our last question comes from Tyler Brown from Raymond James.

Tyler Brown – Raymond James

Thanks. Just a couple of modeling questions for Mike. Does your concession, duties step up in ’12 and would you view that as material cost?

Michael Upchurch

It does step up. I believe it’s effective June 30 next year. And that goes up from 75 basis points, so ¾ of a percent to 1.25%.

Tyler Brown – Raymond James

Okay. Is that the only step up, at least over the term of the remaining concession?

Michael Upchurch

Yes. And that is disclosed in our K, so you can just verify that. But I believe that’s accurate, 0.75 to 1.25.

Tyler Brown – Raymond James

Okay. And then on the cash flow, can you update us on where you are kind of as a cash tax payer? I thought maybe in 2011 you’d be a U.S. payer and then ’12 maybe a Mexican payer. Is that still the case, or is that extended out?

Michael Upchurch

With the incremental benefits on pulling some of the capital forward in the U.S. it looks like we’ll be able to probably push out being a cash tax payer until 2013. But in Mexico, in all likelihood we would be a cash tax payer in 2012.

Tyler Brown – Raymond James

Okay. And then, Pat, I just had one final question. Just, you know, UP, [inaudible] interesting comment that you and UP had won a recent coal fired power plant. I don’t know if there was any – if you can make any public comments about that or anything around that?

Pat Ottensmeyer

No, we’re not in a position to give any more detail on that. We’re still in negotiation for that contract.

Tyler Brown – Raymond James

All right. Fair enough. Thank you.

Michael Upchurch

Hey, Tyler, Mike Upchurch. Just – I looked at the Q, it is 25% of revenue today going to 1.25 in June of 2012.

Tyler Brown – Raymond James

Okay. Thank you.

Operator

Thank you. I’ll know turn the call back over to Mr. Haverty for closing comments.

Michael Haverty

Thank you very much. I think that concludes the presentation and I think things went well. And we’ll see you next quarter. Thank you.

Operator

This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Kansas City Southern Q2 2011 Results - Earnings Call Transcript
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