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CSX Corporation (NYSE:CSX)

Q3 2007 Earnings Call

October 17, 2007 8:30 am ET

Executives

David Baggs - Investor Relations

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

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

Clarence W. Gooden - Executive Vice President and ChiefCommercial 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 AmericaSecurities

Chris Weatherby - Merrill Lynch

William Greene - Morgan Stanley

Gary Chase - Lehman Brothers

John Larkin - Stifel Nicolaus

Jason Seidl - Credit Suisse

David Seinberg - Goldman Sachs

Operator

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

David Baggs

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

Here representing CSX this morning are Michael Ward, the company’sChairman, President and Chief Executive Officer; Tony Ingram, Chief OperatingOfficer; Clarence Gooden, Sales andMarketing Officer; and Oscar Munoz, Chief Financial Officer.

Before we begin the formal part of our program, let meremind everyone that the presentation and other statements made by the companycontain forward-looking statements and actual performance could differmaterially from the results anticipated by these forward-looking statements.

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

Michael J. Ward

Thank you, David and good morning, everyone. The thirdquarter results we announced yesterday show the continued leadership ability ofour team to help solve America’s pressing transportation problems while drivingbetter safety and service for our customers at higher productivity and valuefor the shareholders.

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

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

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

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

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

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

As I mentioned earlier, the economic challenges we arefacing in several markets are simply a reality that we are dealing with. Webelieve the issues are temporal and see strong evidence of a robusttransportation environment long-term.

Our board and management team recognize the need to investfor the future, even as we continue to return capital to our shareholdersthrough our dividend and share repurchase programs.

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

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

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

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

Tony L. Ingram

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

Productivity is also improving, working to help offsetinflation and drive the operating ratio lower. We are running the plan and keyservice measures improved across the board. Customers rated CSX number one inoverall 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 continuedin the third quarter. In the yellow box, you see personal injuries at 1.24 forthe quarter, an improvement of 17% versus 2006. Average frequency for therolling 12 months improved to 1.24, on the trend of improvement. Trainaccidents were 2.79 for the quarter and improved 14% compared to the prioryear. For the rolling 12 months, they improved 19% to 2.98.

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

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

The positive trend will continue as we build on thissuccess.

Looking at slide 9, our asset productivity continues toimprove. On average, dwell was 22 hours in the quarter, about 10% improvementversus 2006, and the positive trend continues on a rolling 12 months. Ourterminals are running the plan every day and remain fluid. Cars-on-line remainat good levels, averaging 221,000 cars for the quarter. Lower volume combinedwith 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 therolling 12 months. Improvement in average velocity is very positive, but stablevelocity performance is also important. In the end, this leads to moreconsistent service for our customers. Better plan execution, combined withfocus capacity investments, is producing this steady improvement.

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

Second, in this period of lower volume, we are adjusting theoperating plan. This drives reduction in resources and manpower levels. Inaddition, 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, ourTSI initiative will improve both customer service and network productivity.

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

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

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

Clarence W. Gooden

Thank you, Tony and good morning, everyone. The thirdquarter again proved that working with our customers in a free marketenvironment is the best way to sustain a vibrant rail industry and globalcompetitive advantage for our customers. This morning, I will highlight ourresults, the primary driver of those results, and offer insights on what we seeahead for the remainder of 2007.

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

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

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

During the third quarter, overall revenue per unit increased8%. The bars on the chart reflect the increase in price on a same-store salesbasis, which excludes the impact from fuel and mix. Same-store sales aredefined as shipments with the same customers, same commodities and car typesshipped between the same origin and destination. These shipments representapproximately 75% of our total traffic base.

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

Future pricing gains are critical for CSX and the entireindustry for us to continue to invest in our networks and to meet the long-termdemand for rail transportation.

Now let’s look at the markets. Quarterly merchandise revenueof nearly $1.3 billion increased over 3%. This growth was driven by strongeryields in all markets as revenue per unit increased almost 9%, more thanoffsetting the weakness in volumes. We saw the most significant volume declinesin our forest products and food and consumer markets, where the softness in the housing sectorreduced 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 offsetby yield improvements, again reflecting our strong service product.

Reviewing the results in coal, quarterly coal revenuesimproved to $650 million, an increase of nearly 8%. Continued strong demand forexport coal during the quarter nearly offset declines in shipments to utilitiesas eastern coal utility stockpiles remained at target levels.

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

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

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

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

From a volume perspective, international traffic was down17% due to losses across a few accounts and slower import growth from Asianmarkets, new shorter haul train services into and out of Atlanta andChambersburg, Pennsylvania, as well as other new dedicated train services drovegrowth in domestic traffic by more than 10%. These new services will continueto be a catalyst for growth going forward.

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

As you can see in the near term, revenue is expected to befavorable 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 thestrength in the export market and the favorable pricing environment. While theoutlook for the auto market is neutral, the revenue outlook for merchandise isgenerally favorable, although continues softness in the housing sector willimpact volume and revenue in the forest products in the food and consumermarkets. The fourth quarter outlook for intermodal is unfavorable, although wesee continuing benefits from improved operations and our new services.

Thank you very much and let me turn the presentation over toOscar 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 discontinuedoperations. Michael mentioned this morning, and as you can see on slide 22, werecorded $0.67 from continuing operations, which represent a decrease of $0.04from the prior year.

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

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

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

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

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

Now let me review our expenses in more detail, starting withlabor 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 offsettingthis increase was a reduction in train crew headcount, reflecting our continuedfocus on productivity and cost control.

On a full year basis, we continue to expect our labor andfringe expenses to increase less than inflation as we achieve our productivityobjectives.

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

In this particular quarter, inflation was mostly offset by adecrease in costs associated with our reduction in train accidents, which was a14% reduction. This reflects the continued improvement in our safetyperformance and all of the associated cost.

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

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

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

Now if I can, let me update you on where we stand on ourshare 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, wehave completed slightly over half of our current $3 billion program and remainon track to finish the program by the end of 2008.

In total, our share repurchase program representsapproximately 15% of the company’s current market cap and is consistent withour balance approach of investing in the business, returning value toshareowners through share repurchases and dividends.

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

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

Michael J. Ward

Thank you, Oscar. Well, we’ve come a long way, both as anindustry and as a company. You are seeing us make the transition from acyclical company largely at the mercy of economic swings, to a company that canmanage through periods of softness and still deliver exceptional results forshareholders.

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

In 1980, one out of every four rail miles in this countrywas owned by a company in bankruptcy. Today, railroads are paying their ownway, investing heavily in the future of our essential service and rewardingshareholders.

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

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

Because we believe that what comes out of Washington will bebalanced, and because we believe in ourselves and the long-term transportationenvironment, we are investing nearly $5 billion in our network over the nextthree years.

These investments will help keep America’s rail systemstrong and safe, while ensuring that shareholder value is sustained over thelong 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 ourcustomers. That is happening and it is happening because of the investment wemake and because of our employees, who meet the needs of our customers everyday.

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

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

With that, we’ll take your questions.

David Baggs

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

Question-and-AnswerSession

Operator

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

Edward Wolfe - BearStearns

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

Tony L. Ingram

You noted the issues that we tried to address with thevolume. The volume is, as we put it in our model, our one plan is able to readjustthe 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 yourimprovements that you see will be on an ongoing basis because that’s throughour discipline and leadership program, along with some of the capitalinvestments we’ve made will continue to help us improve our operations.

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

Edward Wolfe - BearStearns

Am I wrong then in assuming that less volume is sometimeshelpful as you -- I mean, it seems like your metrics have done better when yourvolume 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 areable to reduce trains and slots instead of the size of the trains, yes, it willhelp you on your --

Michael J. Ward

If we look back to 2004, it was a similar period where wehad similar amounts of gross ton miles, which is the key work characteristicthere, and if you look at the two periods, there is significant improvement inall of the key operating measures. So while the volume does help a little bitsequentially, 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 theoperating team.

Edward Wolfe - BearStearns

I’m not denying there’s not a big improvement. I’m justtrying to understand in terms of the degree how we should think of that asvolume 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 beendriven by the cultural change and the discipline around the one plan.

Edward Wolfe - BearStearns

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

Clarence W. Gooden

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

Edward Wolfe - BearStearns

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

Clarence W. Gooden

That’s fair.

Edward Wolfe - BearStearns

Okay, and just bigger picture, Michael, you talked a littlebit about the rail re-reg and that you are confident that cooler heads willprevail. It looks like the safety bill is going to make its way on to the Housefloor this week, possibly. What is your sense of what the impact from a billlike 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 goingto have to go into reconciliation here and it will be a little easier to judgethat once we know what that reconciliation is. I think we believe that thesenate version is probably more appropriate for our industry.

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

Edward Wolfe - BearStearns

Thank you for the time. I appreciate it.

Operator

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

Thomas Wadewitz -J.P. Morgan

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

Oscar Munoz

I think the process that we go through, that Tony goesthrough primarily, with his organization is to look forward with volumes andadjust both the hiring and the furlough aspect of our future business. Soagain, depending on how volumes will work, we’ll continue to pull that lever. Idon’t want to give a specific factor figure because again, it will depend onvolumes and we are trying to stay relatively flexible on that. But what you didsee this quarter is a pretty significant reduction and we should see thatholding 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 benefitas we do it.

Thomas Wadewitz -J.P. Morgan

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

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

Michael J. Ward

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

Thomas Wadewitz -J.P. Morgan

And just in terms of the terminal network, you think that’spretty 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 fromBB&T Capital Markets.

John L. Barnes -BB&T Capital Markets

Good morning. Two questions; one, as you look at thispersistent industry-wide volume weakness and I hear it from all modes oftransport -- things obviously look a little bit weaker right now. Have you guysgiven any further thought to your CapEx budget? I know you laid it out at youranalyst meeting but how quickly can you modify it if this volume stays at theselevels and we don’t see any marked improvement in car loads going forward? Howquickly can you make adjustments to that CapEx and what would end up happeningwith 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 makingare 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 issuesreally portend long-term issues and we are making these investments really forthe long-term, so as you saw in this quarter, even in this weaker environmentwe had very good results. We anticipate we will continue to do so and generatethe cash flow to be able to make the capital investments for the future, toobviously continue to pay our dividend and our share repurchase program, ourthree legs of our balanced approach.

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

John L. Barnes -BB&T Capital Markets

The other thing was, my other question was you guys areahead of where I projected you would be on the share buy-back at this point. Ithink 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 justkind of curious as to what your thinking is on a go-forward basis. Do you do somethingmore methodical on a share repurchase authorization on a go-forward basis or doyou think you are coming back out with another $3 billion type of authorizationat 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 isfinished, we will once again look at all the factors and decide what actions wetake 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 fromBanc Of America Securities.

Scott D. Flower -Banc Of America Securities

Good morning, all. Actually, maybe a couple of questions forClarence. First and second quarter, Clarence, did mix have a more favorable ora 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 tocontinue -- maybe a step back; where are you in terms of coverage of your fuelsurcharge and has that been moving up this year? Can you give me some sense ofwhere 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 fuelsurcharge.

Scott D. Flower -Banc Of America Securities

And how much is that up year over year, like 5 or 10percentage 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 fromMerrill Lynch.

Chris Weatherby -Merrill Lynch

Good morning. It’s Chris Weatherby in for Ken Hoexter. Justtouching back on the intermodal side for a minute, just curious if you couldcomment on the bit of the backslide we saw in the OR for intermodal. Obviouslyvolumes were a bit weak and pricing I guess non-mix adjusted was a bit weakeras we saw international go negative. Just if you could comment a bit on how weshould 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 lowerinternational volumes and the change in mix, for example, where we have threenow 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 theselosses.

That increase up to an 81.3 operating ratio is just a slightincrease. We do operate, as you’re aware, a fixed network of trains that willbe impacted in the cost side to some extent by the amount of volume that we canput on it. But we didn’t see it arise as a dramatic rise and we are verycognizant of what those costs of operating that fixed network are and we areworking very closely with Tony’s team to take out the cost not only from thestandpoint of crew costs and train start costs but from the standpoint ofequipment 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 somethingcompetitive?

Tony L. Ingram

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

Chris Weatherby -Merrill Lynch

Of course. Fair enough. And then just switching gears a bitto the buy-back, as you guys have mentioned, you got a decent amount done inthe quarter. Debt increased a bit more than we were looking for and yourdebt-to-cap’s around 46, debt-to-EBITDA is about 2.25 times. Where do you thinkyou can stay? I guess what’s the target level, keeping mind that you guys havementioned you want to stay investment graded? Is a little over two timesdebt-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 leverageis 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 atROIC, I guess just thinking about it on a replacement cost basis, obviouslyROIC based on your book values are coming up and looking pretty solid. Where doyou think you stand on a replacement cost basis? I’m sure you guys have donethe analysis. I’m just curious -- is it half that level? Is it somewhere inbetween, higher or lower?

Michael J. Ward

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

All of the investment we are making in the future we feelhave good returns and as we continue to improve our profitability, the overallreturn 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 fromMorgan Stanley.

William Greene -Morgan Stanley

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

Oscar Munoz

No, not at all. I think we are seeing -- we said the100-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 aboutcoal? How long do you think it will be before maybe the utility stockpilesreach a point where we can start to see more meaningful growth in thatcategory?

Clarence W. Gooden

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

William Greene -Morgan Stanley

Okay, so basically not a lot of visibility until we see somecolder weather there. And then on intermodal, can we just talk a little bitabout this short haul move? Can you give us a sense for how much of the growthin the volume there is due to the short haul move and maybe what the RPU is sowe 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 significantamount of the volume, particularly on the domestic side, was in the short haulmoves 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 fromLehman Brothers.

Gary Chase - LehmanBrothers

Good morning, guys. Just a quick one for Clarence, or maybeMichael. When you look at that 2008 goal that you’ve got out there, the 5% to6% in same-store sales, is there any way to give us some flavor for what fallsinto the following buckets? I mean, you’ve got escalation on existingcontracts, you’ve got the rollover of contracts that are rolling to currentmarket rates, and then is there a third bucket? Is there an assumption that themarket continues to grow in terms of the overall baseline? And I guess howimportant is that last component to the 5% to 6%?

Clarence W. Gooden

I would tell you that in the rollover area, there is about25% to 35% is rollover. I would tell you that there is a fairly significantamount that is already renegotiated that will start and kick in on January the1st, and I would tell you that the escalation factor would make up the rest.

Gary Chase - LehmanBrothers

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

Clarence W. Gooden

I think that’s fair.

Gary Chase - LehmanBrothers

Could I just ask a question of Tony as well, just afollow-up to one of the earlier questions? I obviously understand you’ve hadsome beneficial impact from some of the operating initiatives that you’ve putin place and volume has been helpful also. Can we think about volume growth of2% to 3% with continued improvement, understanding you’ll keep driving theoperational 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 onour 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 - LehmanBrothers

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

Tony L. Ingram

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

Gary Chase - LehmanBrothers

Okay, thanks, guys.

Operator

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

John Larkin - StifelNicolaus

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

Clarence W. Gooden

Actually, Tony mentioned that but the survey was done by JDPower & Associates and we have beendoing that since 2002. We started off in 2002 in not as good a shape as wewould like to have been. This year, for two consecutive quarters, we’ve beenranked in that survey by our customers in the top position. We surveyed morethan 10,000 customers. There’s 15 different parameters from order fulfillmentto service to contract negotiations to customer service to sales rep, toconsistency of transit, that are measured in that.

John Larkin - Stifel Nicolaus

And are you compared just to your geographic competitor ormore 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 completelyscientific thing. It is polling our customers and asking if they use the otherroads and if so, what is their experience with the other roads.

John Larkin - StifelNicolaus

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

Michael J. Ward

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

John Larkin - StifelNicolaus

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

Clarence W. Gooden

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

John Larkin - StifelNicolaus

Well, congratulations on the big improvement there.Secondly, the State of Florida is one of the two regions in the country alongwith Southern California that has been most hard hit by overbuilding in thehousing market. Given that you are the primary railroad in the State ofFlorida, how much of the volume softness can be traced to the State of Floridaand 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 inventorythere?

Clarence W. Gooden

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

John Larkin - StifelNicolaus

Thank you. And then, on the regulatory front, I think youmade your viewpoint pretty clear on the prospects for re-regulation. You talkeda little bit about your thoughts on how cost of capital ought to be calculatedand that sort of thing. There’s another issue out there and that’s thestreamlined process for smaller shippers to contest rate cases. I think, if I’mnot mistaken, Dupont is kind of working there way through that process now, asalmost a test case. Any thoughts on whether that process will have any negativeimpact going forward?

Michael J. Ward

As you know, John, that’s a pretty new process and you’reright that Dupont is going to be a test case on that. These are just part ofthe business. The challenges that Dupont is given is only on seven moves out ofthe 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 wethink our prices are fair and competitive and we are going to go through thatSDB 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 itdoesn’t. But we think it’s a process -- we’ll have to see how it works goingforward and there’s really not enough knowledge yet about how it works.

John Larkin - StifelNicolaus

Would you anticipate a lot of additional customers maybeavailing 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 Dupontcases. I don’t think there’s any other small shippers cases filed against anyclass one railroad at this point, so it doesn’t appear at this time to be aflood of cases coming through the door.

John Larkin - StifelNicolaus

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

Clarence W. Gooden

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

John Larkin - StifelNicolaus

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

Clarence W. Gooden

No, sir.

John Larkin - StifelNicolaus

All right. Thanks very much.

Operator

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

Jason Seidl - CreditSuisse

Thank you. Good morning, gentlemen. A couple of quickquestions; Clarence, you mentioned obviously that international intermodal ismuch weaker than the domestic side. When should we look for comps to startgetting easier for the international side?

Clarence W. Gooden

The second half of 2008, Jason.

Jason Seidl - CreditSuisse

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

Clarence W. Gooden

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

Three percent even in domestic?

Clarence W. Gooden

Even in domestic.

Jason Seidl - CreditSuisse

Okay, fair enough. Thank you. That’s good. Last question,obviously you brought up the TCI letter. Obviously you had another letter therefrom the UTU, who seem to be -- continue to be a bit disgruntled, and it’s notonly with you guys. It’s with I think the rest of the railroads out there. Doyou guys see the situation with the UTU improving next year, or do you thinkthis is something that’s going to be ongoing and they are going to continue tocreate noise?

Michael J. Ward

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

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

Jason Seidl - CreditSuisse

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 saidthat 25% to 35% percent of the business is rollover, and then you said asignificant amount is locked up that starts January 1. When you say significantamount, are you talking about over 50%?

Clarence W. Gooden

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

Jason Seidl - CreditSuisse

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

Operator

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

David Seinberg -Goldman Sachs

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

Clarence W. Gooden

We don’t know of any, that we have potential losses in thefuture. Yes, the customer is still a customer of CSX, a very good one, I mightadd, 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 ofthe decision that customer made -- was it not to serve certain ports or was itto stop in certain lanes, if they are still a customer? Or did they just notship with you in a given quarter but you are expecting them to come back in thefuture?

Clarence W. Gooden

They shifted some lanes over to a competitive mode oftransportation.

David Seinberg -Goldman Sachs

Thank you very much. And then, one question in terms of yourfourth quarter outlook, the slide that you put up with your expectations forthe 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 fourthquarter? I imagine at this point you have some book of business that you arelooking at, as it relates to both volume and pricing?

Clarence W. Gooden

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

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

David Seinberg -Goldman Sachs

It sounds like, to summarize, more of the same in the fourthquarter 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 EdwardWolfe from Bear Stearns.

Edward Wolfe - BearStearns

Just two quick follow-ups --

Michael J. Ward

Welcome back, Ed.

Edward Wolfe - BearStearns

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 certainlyinto first quarter. When would you expect right now that we start to seepositive 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 of2008, 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, higheroil prices. It’s the unknown for the coal business of what the weather is goingto do over the next couple of quarters. I don’t think the bottom’s going tofall out of it but I don’t think you are going to see the type of growth thatyou and I want to see.

Edward Wolfe - BearStearns

And I’m guessing that you see the same for the industry? CSXisn’t doing something different or comps aren’t any different than anybodyelse?

Clarence W. Gooden

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

Edward Wolfe - BearStearns

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

Clarence W. Gooden

It’s just a sense.

Edward Wolfe - BearStearns

Second question, Oscar, real quick; any thoughts yet toCapEx in ’08 and is there a little bit of extra pressure on you guys right nowwith the regulators watching so closely to continue to spend the money andinvest 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 butthere is pressure we’re putting on ourselves to continue to improve ourinfrastructure and prepare for the future that’s going to make us want tocontinue spending at the levels that Oscar mentioned.

Edward Wolfe - BearStearns

Okay. Thanks, guys.

Michael J. Ward

Thank you for your attendance at our call today.

Operator

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

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