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Executives

David Baggs - Investor Relations

Michael J. Ward - Chairman of the Board, President, Chief Executive Officer

Tony L. Ingram - Executive Vice President and Chief Operating Officer of CSX Transportation, Inc.

Clarence W. Gooden - Executive Vice President and Chief Commercial Officer of CSX Corporation and CSX Transportation, Inc.

Oscar Munoz - Chief Financial Officer, Executive Vice President of CSX Corporation and CSX Transportation, Inc.

Analysts

Edward Wolfe - Bear Stearns

Thomas Wadewitz - J.P. Morgan

John L. Barnes - BB&T Capital Markets

Scott D. Flower - Banc Of America Securities

Chris Weatherby - Merrill Lynch

William Greene - Morgan Stanley

Gary Chase - Lehman Brothers

John Larkin - Stifel Nicolaus

Jason Seidl - Credit Suisse

David Seinberg - Goldman Sachs

CSX Corporation (CSX) Q3 2007 Earnings Call October 17, 2007 8:30 AM ET

Operator

Good morning, ladies and gentlemen and welcome to the CSX Corporation third quarter 2007 earnings call. As a reminder, today’s call is being recorded. (Operator Instructions) For opening remarks and introductions, I would like to turn the call over to Mr. David Baggs, Assistant Vice President, Investor Relations for CSX Corporation.

David Baggs

Thank you and good morning, everyone and again, welcome to CSX Corporation’s third quarter 2007 earnings presentation. The presentation material that we’ll review this morning, along with our quarterly financial report and our safety and service measurements, are available on our website at csx.com under the investor section. In addition, following the presentation this morning, a webcast and podcast replay will be available.

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

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

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

Michael J. Ward

Thank you, David and good morning, everyone. The third quarter results we announced yesterday show the continued leadership ability of our team to help solve America’s pressing transportation problems while driving better safety and service for our customers at higher productivity and value for the shareholders.

If I could just take a moment here, I realize that many of you are interested in the letter we received yesterday from the Children’s Investment Fund. I can assure you that the board values the opinion of all of its shareholders and is reviewing the letter. In the meantime, we remain focused on being safer, providing better service, and being more productive.

Our focus on these and every other aspect of operating the railroad is the reason we were able to continue delivering strong results in spite of some weakness in parts of the economy. We think this says a great deal about the sustainability of our businesses and the relentless drive of our team.

The company continues to increase its core earning power. Earnings per share from continuing operations were up 24% from last year when you factor our insurance recoveries and tax settlements.

The higher service levels and the clear advantage of riding our rails versus other modes of transportation are supporting continued strength in pricing as we provide value to our customers.

Our service transportation businesses generated record third quarter revenue of $2.5 billion, a 3% increase over 2006 and record third quarter operating income. Higher revenue per unit and productivity gains enabled us to deliver a 78% operating ratio for the quarter and we are going to build on our service improvements and further strengthen our focus on cost as we drive toward a mid- to low-70s operating ratio by 2010.

Safety and service levels are at historical highs for our company. Safety, as we’ve told you before, is the bedrock of our operations and it’s a core value of our company. As we continue to get significantly better in an industry that is among the best in safety, we will learn from incidents like the one last week in Paynesville, Ohio. We are thankful that no one was injured and we are grateful to the citizens for their patience as we work through with local officials to mitigate this situation as quickly as possible.

As I mentioned earlier, the economic challenges we are facing in several markets are simply a reality that we are dealing with. We believe the issues are temporal and see strong evidence of a robust transportation environment long-term.

Our board and management team recognize the need to invest for the future, even as we continue to return capital to our shareholders through our dividend and share repurchase programs.

Our disciplined strategy of investing to meet America’s growing transportation needs is consistent with our industry peers, who as a group invested nearly $7 billion last year in infrastructure capital.

We are proud that our financial results, total share holder returns, and our commitment to returning capital to the shareholders lead the industry. CSX continues to perform well versus its peers and the transportation industry in general. Over the past three years, our shareholders have seen returns in the top 10% of all S&P 500 companies.

We believe that CSX has delivered superior performance and the company has demonstrated a commitment to meaningful enhancement of shareholder value in the future.

Now, let me turn the presentation over to Tony who will discuss how we are making our operations increase to the next level.

Tony L. Ingram

Thank you, Michael. Good morning, everyone. Our consistent model of leadership, discipline, and execution is producing great results. First, safety remains at all-time highs. Most recent FRA data shows CSX ranked in the top two and the positive trends will continue.

Productivity is also improving, working to help offset inflation and drive the operating ratio lower. We are running the plan and key service measures improved across the board. Customers rated CSX number one in overall satisfaction in a recent third-party survey.

Now let’s look at the results in more detail.

Slide seven shows the excellent trends in safety continued in the third quarter. In the yellow box, you see personal injuries at 1.24 for the quarter, an improvement of 17% versus 2006. Average frequency for the rolling 12 months improved to 1.24, on the trend of improvement. Train accidents were 2.79 for the quarter and improved 14% compared to the prior year. For the rolling 12 months, they improved 19% to 2.98.

These results reflect our strong commitment to safety and reaching even higher levels of performance.

Now let’s look to on-time train performance, a key driver of service reliability. On-time originations increased to 83% in the quarter, another all-time high for CSX. For the rolling 12 months, performance improved to 78%. On-time arrivals were 76% for the quarter and improved to 69% for the rolling 12 months. The train network is running well and our focus on plan execution is producing results.

The positive trend will continue as we build on this success.

Looking at slide 9, our asset productivity continues to improve. On average, dwell was 22 hours in the quarter, about 10% improvement versus 2006, and the positive trend continues on a rolling 12 months. Our terminals are running the plan every day and remain fluid. Cars-on-line remain at good levels, averaging 221,000 cars for the quarter. Lower volume combined with improved car turns pushed the car counts down.

Now let’s look at another measure of network performance -- velocity. Velocity improved to 21.4 miles per hour in the third quarter and to 20.4 for the rolling 12 months. Improvement in average velocity is very positive, but stable velocity performance is also important. In the end, this leads to more consistent service for our customers. Better plan execution, combined with focus capacity investments, is producing this steady improvement.

Turning to slide 11, we are driving productivity gains and help to push the operating ratio lower. First, better is cheaper. The network is more efficient and the most evidence is in car hour. Oscar will discuss the details later.

Second, in this period of lower volume, we are adjusting the operating plan. This drives reduction in resources and manpower levels. In addition, structured teams are delivering a pipeline of productivity projects. For example, we are using GPS technology to improve asset utilization, frame handling, and fuel efficiency.

Finally, as we discussed at the investors conference, our TSI initiative will improve both customer service and network productivity.

Wrapping up on slide 12, our plan is working and we will continue to build on a solid foundation with leadership, discipline and execution. The great momentum you see in safety and service reliability will continue. We can achieve even better results.

Finally, we’re driving productivity with a structured and disciplined approach to push the operating ratio even lower.

Now let me turn the presentation over to Clarence to review the sales and marketing results.

Clarence W. Gooden

Thank you, Tony and good morning, everyone. The third quarter again proved that working with our customers in a free market environment is the best way to sustain a vibrant rail industry and global competitive advantage for our customers. This morning, I will highlight our results, the primary driver of those results, and offer insights on what we see ahead for the remainder of 2007.

CSX achieved another successful quarter of revenue growth, despite the continued volume weakness. Revenues increased over 3% to a third quarter record of $2.5 billion, exceeding the prior year by $83 million, as yield improvements more than offset the impacts of lower volumes. These yield improvements continue to reflect the superior value we are providing our customers through improved service.

This builds on our success in delivering uninterrupted quarterly revenue growth for more than five years.

Now let’s look at pricing on the next slide. Price continues to drive revenue per unit growth. The line on this chart reflects the year-over-year change in total revenue per unit, which includes the impact of price, fuel, and mix.

During the third quarter, overall revenue per unit increased 8%. The bars on the chart reflect the increase in price on a same-store sales basis, which excludes the impact from fuel and mix. Same-store sales are defined as shipments with the same customers, same commodities and car types shipped between the same origin and destination. These shipments represent approximately 75% of our total traffic base.

Same-store sales price increases were 6.5% for the quarter and is consistent with our 6% to 7% target for 2007. Based on the value that we are providing to our customers through improved service, we expect the momentum to continue. In 2008, we expect to deliver 5% to 6% in same-store sale price increases, which is consistent with previous guidance.

Future pricing gains are critical for CSX and the entire industry for us to continue to invest in our networks and to meet the long-term demand for rail transportation.

Now let’s look at the markets. Quarterly merchandise revenue of nearly $1.3 billion increased over 3%. This growth was driven by stronger yields in all markets as revenue per unit increased almost 9%, more than offsetting the weakness in volumes. We saw the most significant volume declines in our forest products and food and consumer markets, where the softness in the housing sector reduced shipments of lumber, building products, and roofing granules.

We had the most significant revenue gains in phosphates, agricultural products, and chemicals. The volume declines were more than offset by yield improvements, again reflecting our strong service product.

Reviewing the results in coal, quarterly coal revenues improved to $650 million, an increase of nearly 8%. Continued strong demand for export coal during the quarter nearly offset declines in shipments to utilities as eastern coal utility stockpiles remained at target levels.

Revenue per unit increased 10% in the quarter and we expect the favorable pricing environment to continue as we reprice long-term contracts to current market levels.

Now turning to the automotive results, quarterly automotive revenue of nearly $200 million increased 8%. The increase in production of light vehicles more than offset the decline in SUV volumes. Pricing actions resulted in an increase in revenue per unit of 6% and the pricing outlook remains favorable going forward.

Long-term, we are well-positioned within our diverse portfolio of business with the big three and will continue to be supplemented with additional growth from the new domestics.

Turning to our intermodal results, quarterly intermodal revenue of $337 million declined 7%, driven by mix in lower volume as declines in international traffic more than offset the increases in domestic traffic. Overall revenue per unit decreased 1% due to the mix impacts from shorter haul but profitable traffic. However, the same-store sales price for intermodal increased more than 3% for the quarter.

From a volume perspective, international traffic was down 17% due to losses across a few accounts and slower import growth from Asian markets, new shorter haul train services into and out of Atlanta and Chambersburg, Pennsylvania, as well as other new dedicated train services drove growth in domestic traffic by more than 10%. These new services will continue to be a catalyst for growth going forward.

Now let’s take a look at the revenue outlook for the fourth quarter. Overall, our fourth quarter revenue outlook is positive. Pricing strength will continue to be the key driver across all markets. We remain committed to providing excellent service and value for our customers and we will not sacrifice price for short-term volume gains.

As you can see in the near term, revenue is expected to be favorable in six of our 10 markets, neutral in one, and unfavorable in three. Coal, Coke and Iron Ore revenues are expected to remain strong, due to the strength in the export market and the favorable pricing environment. While the outlook for the auto market is neutral, the revenue outlook for merchandise is generally favorable, although continues softness in the housing sector will impact volume and revenue in the forest products in the food and consumer markets. The fourth quarter outlook for intermodal is unfavorable, although we see continuing benefits from improved operations and our new services.

Thank you very much and let me turn the presentation over to Oscar to review our financial results.

Oscar Munoz

Thank you, Clarence and good morning, everyone. Yesterday, CSX reported earnings per share of $0.91, including $0.24 from discontinued operations. Michael mentioned this morning, and as you can see on slide 22, we recorded $0.67 from continuing operations, which represent a decrease of $0.04 from the prior year.

Start at the top of the slide and work our way down, in this quarter we saw surface transportation operating income of $552 million, reflecting the improved operating performance and this team’s focus on delivering consistent financial results.

Moving below the line, other income decreased $8 million, reflecting lower real estate and resort income. Next, interest expense increased $5 million as we issued $1 billion of incremental debt in early September. Finally, our income taxes are $84 million higher, primarily due to a prior year benefit.

Turn to the next slide, let’s look at our results on a more comparable basis. After removing the prior year insurance gains and income tax benefits, EPS from continuing operations increased $0.13 or 24% on a comparable basis. Looking at operating income after removing the gain on insurance recoveries for both years, our surface transportation businesses increased earnings $77 million, or 16%.

Now let’s walk through the details of our results on the next slide. As Clarence just discussed, we have seen more than five years of uninterrupted top line growth. In total, continued strength in yields more than offset our decline in volume, resulting in over 3% or $83 million in revenue growth for the quarter. This top line growth, combined with our stronger operations and improved productivity and lower volume resulted in a $77 million or 16% improvement in operating income.

The same drivers improved the company’s operating ratio 240 basis points or 78%. This performance continues our industry-leading momentum that we’ve established over the last three years and as we’ve improved our operating ratio nearly 1,000 basis points, and positions us for our drive towards a mid- to low-70s OR by 2010.

Now let me review our expenses in more detail, starting with labor fringe. As you can see on slide 25, our labor costs increased only 1%, or $10 million, primarily driven by inflation of $24 million. Partially offsetting this increase was a reduction in train crew headcount, reflecting our continued focus on productivity and cost control.

On a full year basis, we continue to expect our labor and fringe expenses to increase less than inflation as we achieve our productivity objectives.

Moving to the next slide, MS&O, which increased 1% or only $6 million over the last year. As we’ve talked about before, this is a line item that fluctuates from quarter to quarter. Our safety performance, volume, collection activities and other items can all have an impact on these results.

In this particular quarter, inflation was mostly offset by a decrease in costs associated with our reduction in train accidents, which was a 14% reduction. This reflects the continued improvement in our safety performance and all of the associated cost.

Let’s talk about fuel on the next slide. Overall, fuel increased 2% or $5 million versus last year. A $0.16 increase in the average fuel price per gallon resulted in $22 million of additional cost. This was partially offset by a decline in volume and ton miles and by the continued focus on fuel efficiency. In the third quarter alone, improvements in fuel efficiency reduced fuel costs by $10 million compared to the prior year.

Now let me talk about rents on the next slide. As Tony mentioned earlier, the continued improvement in operational fluidity has significantly increased our asset utilization. This, combined with lower volumes in our merchandise and intermodal markets, resulted in a 14% or $19 million decline in rent. On a go-forward basis, you should expect our rent expense to move with our business volumes and continue to benefit from the improvements in asset utilization.

On the next slide, let me review the remaining expenses. All other expenses increased 1% versus prior year. The main driver was depreciation, which is higher due to our net increase in our capital asset base and was partially offset by lower purchase transportation services.

Now if I can, let me update you on where we stand on our share repurchase program. On slide 30, during the third quarter we repurchased $882 million, or just over 20 million shares of our common stock. To date, we have completed slightly over half of our current $3 billion program and remain on track to finish the program by the end of 2008.

In total, our share repurchase program represents approximately 15% of the company’s current market cap and is consistent with our balance approach of investing in the business, returning value to shareowners through share repurchases and dividends.

Wrapping up, these results represent a record third quarter operating income and were driven by solid revenue growth and improved operational productivity, reinforcing our view of the company’s long-term prospects. As a reminder, our long-term financial targets are to deliver double-digit growth in operating income and earnings per share through 2010, growing off a record 2007 base. This financial growth is supported by nearly $5 billion of investment over the next three years as we continue to capitalize on the long-term secular trends in the industry.

With that, let me turn it back over to Michael for his closing remarks.

Michael J. Ward

Thank you, Oscar. Well, we’ve come a long way, both as an industry and as a company. You are seeing us make the transition from a cyclical company largely at the mercy of economic swings, to a company that can manage through periods of softness and still deliver exceptional results for shareholders.

America needs railroads more than ever and railroads are stepping up to the challenge. It’s no secret to any of you that just as the industry is beginning to turn the corner financially, there are those who would like to turn the clock back to the days of regulation.

In 1980, one out of every four rail miles in this country was owned by a company in bankruptcy. Today, railroads are paying their own way, investing heavily in the future of our essential service and rewarding shareholders.

In September, I told you I was optimistic that good policy would prevail. After the recent hearings in Washington, I remain optimistic. I believe policy makers are going to recognize the risk that re-regulation would pose, particularly with respect to investment in America’s rail system.

At the same time, the federal agencies that regulate railroads are becoming increasing active in addressing concerns of our industry and I believe that there’s a growing sentiment that the railroads should be allowed to continue working without re-regulation legislation.

Because we believe that what comes out of Washington will be balanced, and because we believe in ourselves and the long-term transportation environment, we are investing nearly $5 billion in our network over the next three years.

These investments will help keep America’s rail system strong and safe, while ensuring that shareholder value is sustained over the long haul. That’s how the free market system works in this and every other industry. Our investments turn into value when we create better service for our customers. That is happening and it is happening because of the investment we make and because of our employees, who meet the needs of our customers every day.

So we have a vibrant enterprise. Investments are being made, customers are being served, employees and communities are safer than ever, and shareholders are benefiting too. In the past three years, you’ve benefited in a big way. Your investment has grown because of the performance of our company has caused the share price to increase significant. And you’ve been rewarded because of our balanced approach to creating value. This includes long-term investments I just described, along with our repurchase and dividend strategies. We know we’re creating value -- real and lasting value.

It’s telling that a 180-year old U.S. rail system, the best rail freight system in the world, holds the key to so many modern problems facing our country. Our employees and our investments are making the solutions possible and those solutions will continue to reward shareholders for many years to come.

With that, we’ll take your questions.

David Baggs

We’ll turn it back over to Verizon to go ahead and have every one queue up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question come from Edward Wolfe from Bear Stearns.

Edward Wolfe - Bear Stearns

This is a question I guess for Tony, but can you talk a little bit about where you are on the spectrum of improving on all these service metrics? Clearly with weaker volumes, that’s got to help, I would think, velocity and dwell and some other things and yet, you’ve been steadily improving for a while now. So can you talk to how much the environment is helping and how much further and how much longer you can continue to have these kinds of improvements?

Tony L. Ingram

You noted the issues that we tried to address with the volume. The volume is, as we put it in our model, our one plan is able to readjust the trains. The trains, we try to maintain a certain car length for the trains. We’ll continue that. Our people are improving, our supervisors are improving, our training efforts are improving. I think that 50% to 60% of your improvements that you see will be on an ongoing basis because that’s through our discipline and leadership program, along with some of the capital investments we’ve made will continue to help us improve our operations.

So there’s some upside as we continue here. Of course, volume affects it. We are always more efficient with bigger trains and more volume but we think we’ve got the technology with our one plan to adjust and stay as close to this as we go forward.

Edward Wolfe - Bear Stearns

Am I wrong then in assuming that less volume is sometimes helpful as you -- I mean, it seems like your metrics have done better when your volume has actually been a little bit less.

Tony L. Ingram

Well, less volume is never good but we try to adjust to it. But it does create some capacity at times when there is less volume and you are able to reduce trains and slots instead of the size of the trains, yes, it will help you on your --

Michael J. Ward

If we look back to 2004, it was a similar period where we had similar amounts of gross ton miles, which is the key work characteristic there, and if you look at the two periods, there is significant improvement in all of the key operating measures. So while the volume does help a little bit sequentially, I think if you look at the base operations of now versus 2004, there is a marked difference with the leadership Tony’s been bringing to the operating team.

Edward Wolfe - Bear Stearns

I’m not denying there’s not a big improvement. I’m just trying to understand in terms of the degree how we should think of that as volume comes back I’m guessing a little bit less on some of those.

Michael J. Ward

It will be a little bit less but I think most of it’s been driven by the cultural change and the discipline around the one plan.

Edward Wolfe - Bear Stearns

Clarence, I think you noted 3% pricing for intermodal same-store. Can you break that down between domestic and international?

Clarence W. Gooden

I don’t have it broken down, Ed, between domestic and international here in front of me. I can get those numbers for you.

Edward Wolfe - Bear Stearns

Directionally, I’m guessing international is a bit stronger than domestic -- is that fair?

Clarence W. Gooden

That’s fair.

Edward Wolfe - Bear Stearns

Okay, and just bigger picture, Michael, you talked a little bit about the rail re-reg and that you are confident that cooler heads will prevail. It looks like the safety bill is going to make its way on to the House floor this week, possibly. What is your sense of what the impact from a bill like that might have on CSX and the other railroads?

Michael J. Ward

Well, as you know, Ed, there’s two very different versions -- the House version and the Senate version. I think obviously they are going to have to go into reconciliation here and it will be a little easier to judge that once we know what that reconciliation is. I think we believe that the senate version is probably more appropriate for our industry.

We see most of the things in there that we can probably live with those and will help improve the safety and I think that most of the other roads would feel the same way.

Edward Wolfe - Bear Stearns

Thank you for the time. I appreciate it.

Operator

Thank you. Our next question comes from Mr. Thomas Wadewitz from J.P. Morgan.

Thomas Wadewitz - J.P. Morgan

Good morning. Let’s see -- I wanted to ask a bit about productivity in terms of where are you on headcount reduction with respect to where the volume level is on the railroad? Is there a bit of a lag where we might see an acceleration in headcount reduction looking forward? Or is it kind of 1.5% reduction in headcount and that’s reasonable to expect for the next couple of quarters if volume remains soft?

Oscar Munoz

I think the process that we go through, that Tony goes through primarily, with his organization is to look forward with volumes and adjust both the hiring and the furlough aspect of our future business. So again, depending on how volumes will work, we’ll continue to pull that lever. I don’t want to give a specific factor figure because again, it will depend on volumes and we are trying to stay relatively flexible on that. But what you did see this quarter is a pretty significant reduction and we should see that holding through the end of the year certainly.

Thomas Wadewitz - J.P. Morgan

So you wouldn’t say that there’s a lag in how that comes in? You had nice productivity on headcount and that continues?

Oscar Munoz

No, I don’t think there’s a lag. I think we get the benefit as we do it.

Thomas Wadewitz - J.P. Morgan

Right, okay. One I guess a kind of a broader strategic question when one of the points that your favorite shareholder highlighted, I guess TCI highlighted in their things yesterday, from an operational perspective, there may be room for longer term to convert with the other rails and you had very significant improvement to this point but is there an opportunity for kind of a step change action, whether it’s changing some of the terminal network or whether it’s kind of broadly revisiting a one plan where you look at the train schedule and blocking and so forth? Is there potentially a big step change driver of improvement or is that not realistic?

I mean, you have shown very good continued process improvement, but I’m just trying to get a sense if you think there’s a big step out there further in the future?

Michael J. Ward

As you know, we did have a pretty big step change there about a year ago and since then, you’ve seen strong continued improvement. I think that’s what we could expect to continue to see -- Tony and his team continuing to drive the strong improvements as we get better around our discipline around the one plan but I don’t see any big step function change that’s out there on the horizon.

Thomas Wadewitz - J.P. Morgan

And just in terms of the terminal network, you think that’s pretty much where it needs to be, you’re comfortable with what it looks like?

Michael J. Ward

Yes.

Thomas Wadewitz - J.P. Morgan

Okay. Thanks for the time.

Operator

Thank you. Our next question comes from Mr. John Barnes from BB&T Capital Markets.

John L. Barnes - BB&T Capital Markets

Good morning. Two questions; one, as you look at this persistent industry-wide volume weakness and I hear it from all modes of transport -- things obviously look a little bit weaker right now. Have you guys given any further thought to your CapEx budget? I know you laid it out at your analyst meeting but how quickly can you modify it if this volume stays at these levels and we don’t see any marked improvement in car loads going forward? How quickly can you make adjustments to that CapEx and what would end up happening with this dollars if you weren’t spending them on expensing CapEx?

Michael J. Ward

John, as you know, a lot of those investments we are making are one, to sustain the current safety and infrastructure we have but secondly, to prepare for future growth. We don’t think that these short-term issues really portend long-term issues and we are making these investments really for the long-term, so as you saw in this quarter, even in this weaker environment we had very good results. We anticipate we will continue to do so and generate the cash flow to be able to make the capital investments for the future, to obviously continue to pay our dividend and our share repurchase program, our three legs of our balanced approach.

We anticipate we will be able to continue to do that and build long-term value.

John L. Barnes - BB&T Capital Markets

The other thing was, my other question was you guys are ahead of where I projected you would be on the share buy-back at this point. I think you are to be applauded for that. What’s your thinking as you get into ’08 and you begin to exhaust the current authorization? I can’t -- I’m just kind of curious as to what your thinking is on a go-forward basis. Do you do something more methodical on a share repurchase authorization on a go-forward basis or do you think you are coming back out with another $3 billion type of authorization at the end of this one?

Michael J. Ward

John, I think we take one step at a time. We have a current $3 billion program out there that we are working on and when that program is finished, we will once again look at all the factors and decide what actions we take and it’s really not appropriate to discuss that at this point.

John L. Barnes - BB&T Capital Markets

I guess. Thanks for your time.

Operator

Thank you. Our next question comes from Scott Flower from Banc Of America Securities.

Scott D. Flower - Banc Of America Securities

Good morning, all. Actually, maybe a couple of questions for Clarence. First and second quarter, Clarence, did mix have a more favorable or a less favorable impact on revenue per unit for you?

Clarence W. Gooden

It had a more favorable.

Scott D. Flower - Banc Of America Securities

More favorable -- demonstrably or just a little bit?

Clarence W. Gooden

Just a little bit.

Scott D. Flower - Banc Of America Securities

Okay, and then on your fuel surcharge, have you been able to continue -- maybe a step back; where are you in terms of coverage of your fuel surcharge and has that been moving up this year? Can you give me some sense of where that stands?

Clarence W. Gooden

Yes, it’s been moving up this year. We are now at about 85% coverage, either with fuel surcharge or RCAFU. We renew no contracts without fuel surcharge.

Scott D. Flower - Banc Of America Securities

And how much is that up year over year, like 5 or 10 percentage points, roughly? Or is it less than that?

Clarence W. Gooden

No, it is somewhere in that range.

Scott D. Flower - Banc Of America Securities

Okay. All right, thanks very much.

Operator

Thank you. Our next question comes from Chris Weatherby from Merrill Lynch.

Chris Weatherby - Merrill Lynch

Good morning. It’s Chris Weatherby in for Ken Hoexter. Just touching back on the intermodal side for a minute, just curious if you could comment on the bit of the backslide we saw in the OR for intermodal. Obviously volumes were a bit weak and pricing I guess non-mix adjusted was a bit weaker as we saw international go negative. Just if you could comment a bit on how we should see the run-rate going forward. You had a big improvement last quarter, a bit of a decline this quarter -- just where do we see that going?

Tony L. Ingram

Our revenue, Chris, declined, reflecting some of the lower international volumes and the change in mix, for example, where we have three now new shorter haul services, one to Chambersburg, Pennsylvania, two to Marion, Ohio and three with the BNSF into Atlanta. We do expect intermodal to begin to grow again in 2008 as we lap some of these losses.

That increase up to an 81.3 operating ratio is just a slight increase. We do operate, as you’re aware, a fixed network of trains that will be impacted in the cost side to some extent by the amount of volume that we can put on it. But we didn’t see it arise as a dramatic rise and we are very cognizant of what those costs of operating that fixed network are and we are working very closely with Tony’s team to take out the cost not only from the standpoint of crew costs and train start costs but from the standpoint of equipment costs.

Chris Weatherby - Merrill Lynch

And then as far as -- you had mentioned customer loss there. Anything that you could share with us on that that’s not too sensitive? I mean, was it a redeployment of assets to different lanes or was it something competitive?

Tony L. Ingram

It was some competitive moves and they were not service related and I don’t want to get into specifics of the customer, because the customer themselves like to keep those things confidential.

Chris Weatherby - Merrill Lynch

Of course. Fair enough. And then just switching gears a bit to the buy-back, as you guys have mentioned, you got a decent amount done in the quarter. Debt increased a bit more than we were looking for and your debt-to-cap’s around 46, debt-to-EBITDA is about 2.25 times. Where do you think you can stay? I guess what’s the target level, keeping mind that you guys have mentioned you want to stay investment graded? Is a little over two times debt-to-EBITDA a good level for you guys or can you increase that a bit?

Oscar Munoz

I think what we’ve said pretty consistently on the leverage is about a 50% target level and I think we’re still staying with that.

Chris Weatherby - Merrill Lynch

Okay, and I guess just real quick, the way you guys look at ROIC, I guess just thinking about it on a replacement cost basis, obviously ROIC based on your book values are coming up and looking pretty solid. Where do you think you stand on a replacement cost basis? I’m sure you guys have done the analysis. I’m just curious -- is it half that level? Is it somewhere in between, higher or lower?

Michael J. Ward

What industry looks at their ROIC on a replacement cost basis? I don’t know of any industry that does that. I think we’ll probably continue to follow the normal traditions of the way people calculate ROIC.

All of the investment we are making in the future we feel have good returns and as we continue to improve our profitability, the overall return is going to continue to increase.

Chris Weatherby - Merrill Lynch

Fair enough. Thanks very much.

Operator

Thank you. Our next question comes from William Greene from Morgan Stanley.

William Greene - Morgan Stanley

Oscar, I’m wondering if you can talk a little bit about the free cash flow projection that you offered at the investor day for 2007. Has that changed at all given the volume trends or how you did here in the third quarter?

Oscar Munoz

No, not at all. I think we are seeing -- we said the 100-plus just a while ago and that’s still our target for this year.

William Greene - Morgan Stanley

Okay, and then for Clarence, can you talk a little bit about coal? How long do you think it will be before maybe the utility stockpiles reach a point where we can start to see more meaningful growth in that category?

Clarence W. Gooden

Obviously it’s weather dependent and generation dependent, and generation in the numbers that came out yesterday for industrial production were actually down. I’m hoping for a cold winter. I just don’t know how to answer you other than that, William.

William Greene - Morgan Stanley

Okay, so basically not a lot of visibility until we see some colder weather there. And then on intermodal, can we just talk a little bit about this short haul move? Can you give us a sense for how much of the growth in the volume there is due to the short haul move and maybe what the RPU is so we can get a sense for how to think about this going forward?

Clarence W. Gooden

I can’t on the RPU but I could tell you that a significant amount of the volume, particularly on the domestic side, was in the short haul moves in the Birmingham to Atlanta lane, in the St. Louis to Marion, Ohio lane, and then to a lesser extent in the Chicago to Chambersburg lane.

William Greene - Morgan Stanley

Okay. Thanks for your help.

Operator

Thank you. Our next question comes from Gary Chase from Lehman Brothers.

Gary Chase - Lehman Brothers

Good morning, guys. Just a quick one for Clarence, or maybe Michael. When you look at that 2008 goal that you’ve got out there, the 5% to 6% in same-store sales, is there any way to give us some flavor for what falls into the following buckets? I mean, you’ve got escalation on existing contracts, you’ve got the rollover of contracts that are rolling to current market rates, and then is there a third bucket? Is there an assumption that the market continues to grow in terms of the overall baseline? And I guess how important is that last component to the 5% to 6%?

Clarence W. Gooden

I would tell you that in the rollover area, there is about 25% to 35% is rollover. I would tell you that there is a fairly significant amount that is already renegotiated that will start and kick in on January the 1st, and I would tell you that the escalation factor would make up the rest.

Gary Chase - Lehman Brothers

Okay, so there’s not much expectation for the market reality changing. It’s really kind of hear today. It’s just a matter of it playing out on the P&L, is that fair?

Clarence W. Gooden

I think that’s fair.

Gary Chase - Lehman Brothers

Could I just ask a question of Tony as well, just a follow-up to one of the earlier questions? I obviously understand you’ve had some beneficial impact from some of the operating initiatives that you’ve put in place and volume has been helpful also. Can we think about volume growth of 2% to 3% with continued improvement, understanding you’ll keep driving the operational improvements but there will be some offset with volume challenge? Is that a reasonable goal?

Tony L. Ingram

I think that’s reasonable. We still have some capacity on our trains to absorb something like that.

Michael J. Ward

And continue to improve.

Tony L. Ingram

And continue to improve at the same time.

Gary Chase - Lehman Brothers

So you think you could do low single digit growth and see those service metrics keep moving in the right direction?

Tony L. Ingram

As far as the service metrics, yes. We could see them continuously improve with that kind of growth.

Gary Chase - Lehman Brothers

Okay, thanks, guys.

Operator

Thank you. Our next question comes from John Larkin from Stifel Nicolaus.

John Larkin - Stifel Nicolaus

Thank you. Good morning, everybody. I thought I heard Clarence mention that you had done a survey or some independent party had done a survey which indicated that CSX showed up as number one in service. Could you give us a little more detail on that, what parameters were measured and who were you compared against? Who did the analysis?

Clarence W. Gooden

Actually, Tony mentioned that but the survey was done by JD Power & Associates and we have been doing that since 2002. We started off in 2002 in not as good a shape as we would like to have been. This year, for two consecutive quarters, we’ve been ranked in that survey by our customers in the top position. We surveyed more than 10,000 customers. There’s 15 different parameters from order fulfillment to service to contract negotiations to customer service to sales rep, to consistency of transit, that are measured in that.

John Larkin - Stifel Nicolaus

And are you compared just to your geographic competitor or more broadly to the whole industry?

Clarence W. Gooden

More broadly to the whole industry, including trucking.

Michael J. Ward

The only thing I would add to that is this is not a completely scientific thing. It is polling our customers and asking if they use the other roads and if so, what is their experience with the other roads.

John Larkin - Stifel Nicolaus

Okay, so there may be some bias towards giving you higher ratings because they are your customers and --

Michael J. Ward

No, I think most customers end up using -- most big customers use most of the big railroads, John. But I just wanted to let you know this is not some nationwide survey, although it is a very broad one, as Clarence indicated.

John Larkin - Stifel Nicolaus

Would it be possible to maybe make a summary of that available to the sell side or Wall Street in general?

Clarence W. Gooden

Actually, John, we’ve kept that internally here so that we could use it to better ourselves, to try to improve as we go forward.

John Larkin - Stifel Nicolaus

Well, congratulations on the big improvement there. Secondly, the State of Florida is one of the two regions in the country along with Southern California that has been most hard hit by overbuilding in the housing market. Given that you are the primary railroad in the State of Florida, how much of the volume softness can be traced to the State of Florida and will that make your volume recovery a little more difficult going forward, since it may take a little longer to absorb all the excess housing inventory there?

Clarence W. Gooden

John, obviously we’ve looked at the housing market in Florida and California, to your point, very closely. Twenty-five percent of the foreclosures in this country have occurred in Florida, 25% in California. Thirty-two percent of the homes bought in Florida in the last three years were primary residences, meaning two-thirds were not. There’s a glut of houses on the market. It impacts our aggregate materials. It impacts our consumer goods, refrigerators, washers, dryers. We’ve been trying to quantify what that number is for some period of time. It’s difficult to quantify it not only from the standpoint of the basic raw building materials of building the house, but it also starts to impact imports with furniture, appliances from overseas. But I would tell you that it is not a pretty picture and it does have an impact on what our volume growth is.

John Larkin - Stifel Nicolaus

Thank you. And then, on the regulatory front, I think you made your viewpoint pretty clear on the prospects for re-regulation. You talked a little bit about your thoughts on how cost of capital ought to be calculated and that sort of thing. There’s another issue out there and that’s the streamlined process for smaller shippers to contest rate cases. I think, if I’m not mistaken, Dupont is kind of working there way through that process now, as almost a test case. Any thoughts on whether that process will have any negative impact going forward?

Michael J. Ward

As you know, John, that’s a pretty new process and you’re right that Dupont is going to be a test case on that. These are just part of the business. The challenges that Dupont is given is only on seven moves out of the hundreds of moves they have with us and probably only represents about 5% of our revenues with them. They are a good customer. We like Dupont but we think our prices are fair and competitive and we are going to go through that SDB process with them.

As you know, the front end of that is a mediation process, which we will engage with with them and perhaps it gets solved then, perhaps it doesn’t. But we think it’s a process -- we’ll have to see how it works going forward and there’s really not enough knowledge yet about how it works.

John Larkin - Stifel Nicolaus

Would you anticipate a lot of additional customers maybe availing themselves of this new process over the next couple of years?

Michael J. Ward

Well, we have not seen a lot. I mean, we have these Dupont cases. I don’t think there’s any other small shippers cases filed against any class one railroad at this point, so it doesn’t appear at this time to be a flood of cases coming through the door.

John Larkin - Stifel Nicolaus

One final one for Clarence. I know that J.B. Hunt, who some might say would be the leader in intermodal in the U.S. currently, has been deriving a lot of its growth in the east, in lanes that heretofore were thought to be a little bit too short to support quality competitive intermodal operations. But that’s where their focus is and I know that they have been chatting with you a little bit, at least. Any thought about whether there might be an opportunity to capture some of that business, perhaps into the New England area or Florida or other areas where you might have an advantage over brand X?

Clarence W. Gooden

Well, we’re talking to customers every day about any opportunity we can get, John, and we never, never say no. It’s always yes, if.

John Larkin - Stifel Nicolaus

But there’s no reason -- you have no exclusive agreement with Schneider or anything that would preclude you from doing business with J.B. Hunt?

Clarence W. Gooden

No, sir.

John Larkin - Stifel Nicolaus

All right. Thanks very much.

Operator

Thank you. Our next question comes from Jason Seidl from Credit Suisse.

Jason Seidl - Credit Suisse

Thank you. Good morning, gentlemen. A couple of quick questions; Clarence, you mentioned obviously that international intermodal is much weaker than the domestic side. When should we look for comps to start getting easier for the international side?

Clarence W. Gooden

The second half of 2008, Jason.

Jason Seidl - Credit Suisse

Second half? Okay. And when we look at the pricing, and I know you don’t have it there but if you can break it down, is pricing on the domestic side, ex some of your new product offerings, is that still up? Are you still seeing pricing gains ex the new product offerings?

Clarence W. Gooden

No, the new product offerings, we wouldn’t be able to compared on a year-over-year basis because they weren’t there last year, so we’re pricing to the market and as you know, that market has got a lot of capacity in it right now, so it is a very difficult pricing environment in those new intermodal markets.

Michael J. Ward

But despite that, on the existing moves you saw about a 3% overall --

Clarence W. Gooden

In existing moves, it’s about three, that’s right.

Jason Seidl - Credit Suisse

Three percent even in domestic?

Clarence W. Gooden

Even in domestic.

Jason Seidl - Credit Suisse

Okay, fair enough. Thank you. That’s good. Last question, obviously you brought up the TCI letter. Obviously you had another letter there from the UTU, who seem to be -- continue to be a bit disgruntled, and it’s not only with you guys. It’s with I think the rest of the railroads out there. Do you guys see the situation with the UTU improving next year, or do you think this is something that’s going to be ongoing and they are going to continue to create noise?

Michael J. Ward

Jason, as you know, they’ve been on a campaign against the entire industry for more than a year now. It’s part of their negotiating strategies around the current round of negotiations.

We’ve reached agreement with all other major unions at this point an we’d like to continue the dialog with the UTU. We think there’s a clear pattern out there and hopefully we’ll be able to engage them at some point in the near future because we think it’s pretty clear. We’ve reached agreement with most other unions and we think we should be able to do the same with the UTU, but obviously they have a harsh rhetoric around this entire issue that hopefully they’ll be able to get over.

Jason Seidl - Credit Suisse

Thank you. Clarence, if I can just come back for a minute, just so I can clarify something you said before to answer a question; you said that 25% to 35% percent of the business is rollover, and then you said a significant amount is locked up that starts January 1. When you say significant amount, are you talking about over 50%?

Clarence W. Gooden

No, I would be talking in the 25% to 30% category there.

Jason Seidl - Credit Suisse

Twenty-five to 30% category. Okay, perfect. Thank you so much for the time, gentlemen.

Operator

Thank you. Our next question comes from David Seinberg from Goldman Sachs.

David Seinberg - Goldman Sachs

Good morning. Two questions; on the intermodal, the international customer that you lost, I wanted to know if that customer is still a customer of CSX and then, as a second part, if any other customers you had an indication were making similar decisions or looking at a similar decision process that led to that customer loss? In other words, are there potential for future customer losses in the future?

Clarence W. Gooden

We don’t know of any, that we have potential losses in the future. Yes, the customer is still a customer of CSX, a very good one, I might add, and we expect to do more business with that customer in the future.

David Seinberg - Goldman Sachs

Maybe you can provide a little more detail then in terms of the decision that customer made -- was it not to serve certain ports or was it to stop in certain lanes, if they are still a customer? Or did they just not ship with you in a given quarter but you are expecting them to come back in the future?

Clarence W. Gooden

They shifted some lanes over to a competitive mode of transportation.

David Seinberg - Goldman Sachs

Thank you very much. And then, one question in terms of your fourth quarter outlook, the slide that you put up with your expectations for the different end markets, can you give a little color in terms of how much of -- in terms of the -- those markets where you are favorable or not favorable, what impact pricing versus volume has in terms of your outlook for fourth quarter? I imagine at this point you have some book of business that you are looking at, as it relates to both volume and pricing?

Clarence W. Gooden

Well, we think that the intermodal volumes will be down for the fourth quarter as a result of some of the lower international volume and it’s due to some of those customer losses we mentioned earlier, as well as a continued slowing of the Asian import growth. We expect the automotive volumes will be down for the fourth quarter. Chrysler, for example, closing some plants on a temporary basis just this week.

Overall, on our merchandise side, we expect the volume to be down. We expect volume gains in some of our commodities. Phosphates would be an example, fertilizers, metals and chemicals, but they will be more than offset by the losses in the housing area. And we talked about coal earlier but just to reiterate it, we expect the fourth quarter volumes will be flat due to the weather issues and being offset a little bit by the export demand growth in our steam coal, and we expect in all of those areas that our pricing in the fourth quarter will continue to be very strong and very robust.

David Seinberg - Goldman Sachs

It sounds like, to summarize, more of the same in the fourth quarter that we saw in 3Q.

Clarence W. Gooden

Yes.

David Seinberg - Goldman Sachs

Thank you very much.

Operator

Thank you. Our last question for today comes from Edward Wolfe from Bear Stearns.

Edward Wolfe - Bear Stearns

Just two quick follow-ups --

Michael J. Ward

Welcome back, Ed.

Edward Wolfe - Bear Stearns

Is this a new conference call or is it the same? Clarence, the volume comps get a bit easier as we go out this quarter and then certainly into first quarter. When would you expect right now that we start to see positive volume comps? And if you don’t want to talk specifically about CSX, for the group generally?

Clarence W. Gooden

I think in CSX's case, it is going to be the second half of 2008, Ed, and it’s based on a lot of factors. It’s the unknown in the housing, it’s the unknown impact on the economy of the fourth quarter’s results, higher oil prices. It’s the unknown for the coal business of what the weather is going to do over the next couple of quarters. I don’t think the bottom’s going to fall out of it but I don’t think you are going to see the type of growth that you and I want to see.

Edward Wolfe - Bear Stearns

And I’m guessing that you see the same for the industry? CSX isn’t doing something different or comps aren’t any different than anybody else?

Clarence W. Gooden

Well, I don’t want to speak for the industry because as soon as I do that, I will have said something that I am not qualified to say.

Edward Wolfe - Bear Stearns

Okay, but do you see something specific to CSX that is going to get you positive in the second half of ’08, or is it just your sense that at that point, visibility has to get better at some point?

Clarence W. Gooden

It’s just a sense.

Edward Wolfe - Bear Stearns

Second question, Oscar, real quick; any thoughts yet to CapEx in ’08 and is there a little bit of extra pressure on you guys right now with the regulators watching so closely to continue to spend the money and invest at this point?

Oscar Munoz

I’ll take the numeric part of the question. I think our -- what we’ve talked about is a 1.6 level of spending in 2008.

Michael J. Ward

I think that there is no pressure on the regulatory side but there is pressure we’re putting on ourselves to continue to improve our infrastructure and prepare for the future that’s going to make us want to continue spending at the levels that Oscar mentioned.

Edward Wolfe - Bear Stearns

Okay. Thanks, guys.

Michael J. Ward

Thank you for your attendance at our call today.

Operator

Thank you, ladies and gentlemen. This concludes this conference call. We thank you for your participation in today’s conference call and ask that you please disconnect your line at this time. Thank you.

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