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CSX Corporation (NYSE:CSX)

Q4 2007 Earnings Call

January 22, 2008 8:30 am ET

Executives

David Baggs - Assistant Vice President, Investor Relations

Michael Ward - Chairman, President and Chief Executive Officer

Tony Ingram - Chief Operating Officer

Clarence Gooden - Chief Sales and Marketing Officer

Oscar Munoz - Chief Financial Officer

Analysts

Tom Wadewitz – J.P. Morgan

John Barnes – BB&T Capital Markets

Scott Flower – Banc of America Securities

Ken Hoexter – Merrill Lynch

William Greene – Morgan Stanley

Edward Wolfe – Bear, Stearns

John Larkin – Stifel, Nicholaus

John Kartsonas – Citigroup Investment Research

Jason Seidl – Credit Suisse

David Feinberg – Goldman Sachs

Operator

Good morning ladies and gentlemen and welcome to the CSX Corporation Fourth Quarter 2007 Earnings Call. [Operator Instructions] For the opening remarks and introduction I would like to turn the call over to Mr. David Baggs, Assistant Vice President, Investor Relations for CSX Corporation.

David Baggs

Good morning everyone and welcome to our Fourth Quarter Earnings Call. The presentation material that we’ll review this morning along with our quarterly financial report and our safety and service measurement are available on our website at www.CSX.com under the investor section. In addition, following the presentation a webcast and pod cast replay will be available for your review.

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

Before we get started our proxy disclosure provides important information about our 2008 annual meeting and we encourage you to read this information for further detail. At the same time please keep in mind that this is an earnings call and our remarks during the presentation and Q&A session will focus on our financial and operational performance. We do not intend to take any questions this morning on other topics.

Also 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.

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

Michael Ward

Good morning everyone. That was another great quarter and another great year for CSX. Once again our team delivered better year over year results, outperformed expectations and continue to generate value for our shareholders. This, despite a softer economy and higher fuel prices. Today we reported fourth quarter net earnings of $0.86 per share up 15% from the $0.75 per share in the fourth quarter of last year. On a comparable basis EPS was $0.85 versus $0.57 last year.

At the Harvest Performance our great operations, Tony and the operating team drove safety and service to all time best levels once again. On the safety front our sustained improvements in reducing personal injuries over the past three years resulted in a favorable reserve adjustment for the quarter. At the same time, our terrific service performance translated into greater value for our customers who are getting more of what they want when they want it. Better service enables us to achieve strong pricing, makes us more productive with our assets and improves the profitability of our business.

This combination resulted in continuing improvement in our operating ratio which was below 77% for the quarter. With this strong momentum we are on our way toward driving the operating ratio to a mid to low 70’s mark that we expect by 2010. For the full year CSX again delivered double digit growth in operating income and earnings per share up 14% and 22% respectively on a comparable basis.

Service transportation revenues increased 5% and exceeded $10 billion for the first time in the company’s history. This reflects the higher quality of our service and the resiliency of the freight/rail marketplace which has allowed us to overcome the affects of the softer environment for housing and auto related products.

Full year operating income was more than $2.2 billion a 14% increase and our operating ratio dropped below 78 for the first time in a decade. The team you are going to hear from today is leading the success across our network.

With that I’ll turn the presentation over to Tony to talk about operations.

Tony Ingram

Good morning everyone. Once again leadership, discipline and execution produced great results for the quarter and for the year. First, safety is at all time best levels, the FRA data shows CSX in the top two railroads. We’ll continue our drive to be the safest network in North America. Second, we continue to be more productive, the gains are offsetting inflation and driving down the operating ratio. We are running to plan; service improved across the board and remained at all time best levels. Let’s look at the results in more detail.

Slide nine shows the excellent trends in safety. In the yellow box you see person injury’s at 1.26 for the quarter, that’s an improvement of 7% over 2006. Average frequency for the full year improved to 1.21 or 17% better than the year before. Train accidents were 2.85 for the quarter, they improved 21% from prior year and for the full year train accidents improved 20% to 2.83. Our continued focus on safety will take us to higher levels of performance in 2008.

Let’s turn to on time performance, a key driver for service. On time originations were 81% for the quarter, the best fourth quarter in our history. For the full year originations increased to 79% another all time best. Keep in mind that we measure origination to the minute. On time arrivals were 73% in the quarter and improved to 70% for the full year. Our focus on planned execution continues to produce strong results.

Looking at slide 11 our network is running well and producing a strong service product for our customers. In the terminals cars are making their connections faster, on average dwell time was about 22 hours in the quarter, that’s an 8% improvement from 2006. The positive trend continued on a rolling 12 months. On the line of road train velocity improved to 21.2 miles per hour in the fourth quarter and 20.8 for the full year. High velocity is positive and stable velocity is key, we are getting both. We are doing it by focusing on the plan and making smart investments. In the end all this leads to more consistent service for our customers.

Let’s turn to slide 12 and see what our customers tell us about our service. Every quarter we’ve surveyed a large number of our customers. They rate our performance compared to trucks and the other rails. In 2007 customers gave us a highest score since the survey began six years ago. In total satisfaction they rated us up there where the best for the quarter and for the year. Our customers are clearly feeling our improvements; better service creates value for our customers and helps us grow the top line.

Wrapping up on slide 13, our plan is working; we will continue to get better and better with our leadership discipline and execution. Our momentum and safety and service will continue and we are driving productivity with discipline and great employees. We’re not done yet.

Let me turn it over to Clarence to review sales and marketing results.

Clarence Gooden

Good morning. The fourth 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 drivers of those results and offer insights in what we see ahead for 2008.

CSX achieved another successful quarter of revenue growth despite the continued softness in the housing and the automotive sectors of the economy. Revenues increased 8% to a fourth quarter record of nearly $2.6 billion exceeding the prior year by $181 million as yield improvements more than offset the impact of lower volume. These yield improvements continue to reflect the superior value we are providing our customers through improved service as well as the impact of higher fuel costs reflected in our fuel recovery programs. This builds on our success in delivering uninterrupted quarterly revenue growth for nearly six years.

Now looking at pricing on the next slide, 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 fourth quarter overall revenue per unit increased 10.5% due to both increased fuel recovery and price increases. 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 6.7% for the quarter which is consistent with the increases you’ve seen over the last three years. Based on the value we are providing to our customers through improved service we expect that momentum to continue at a rate of 5% to 6% for the full year 2008 which is consistent with the expectations we have communicated over the past year.

Now let us look at various markets. Quarterly merchandise revenue of nearly $1.3 billion increased 7% this growth was driven by stronger yields in all markets as revenue per unit increased 11% more than offsetting the weakness in volumes which continue to feel the impact of softness in the automotive and housing sectors. We saw the most significant volume declines in our forest products and food and consumer markets due to reduced shipments of lumber, building products, roofing granules and appliances.

Volumes grew in agricultural products and phosphates and fertilizers due in large part to the increased demand for ethanol. As a result five of the seven merchandise markets increased in revenue with phosphates, agricultural products and chemicals producing the most significant gains. The fourth quarter revenue results were an all time high in agricultural products with double digit increases in feed ingredients and wheat. Ethanol revenue doubled in the quarter versus the prior year.

Let’s turn now and review the results in coal. Quarterly coal revenues improved to $683 million this is an increase of over 13% and represents a new quarterly record. Continued strong demand for export coal during the quarter also offset declines in shipment to utilities as Eastern utility coal stockpiles remain at target levels. Export shipments are exceeding levels that had not been seen since the early 1990’s due to strong overseas demand, limitations from overseas producers, high vessel rates and a weak US dollar. We expect these favorable conditions to continue over the near term.

While the number of car loads was flat the actual tonnage increased nearly 1% as customers put new high capacity cars into service. Revenue per unit increased nearly 14% in the quarter. We expect a favorable pricing environment to continue as we re-price long term contracts to current market levels.

Now turning to our automotive market for its results, quarterly automotive revenue of $215 million increased over 2%. CSX’s volume was consistent with big three production declines in the fourth quarter as the slowing economy and tight credit conditions are impacting auto sales. In addition, the big three reduction in fleet sales and the shift from SUV’s to cross over vehicles hurt CSX volumes. Pricing actions and fuel recovery resulted in an increase in revenue per unit of 5%. Long term we are well positioned with our diverse portfolio business with the big three which will continue to be supplemented with additional growth from the domestics.

Now turning to our Intermodal results, quarterly intermodal revenue of $358 million was flat versus last year as higher revenue per unit offset a decline in volume. Revenue per unit increased due to Intermodal’s continued focus on the bottom line as traffic mix, fuel recovery and yield improvements drove revenue per unit 4% higher in the quarter. The overall volume decrease was driven by the declines in international traffic which was down 17% due to losses across a few accounts in previous quarters and slower import growth from Asian markets.

Partially offsetting the international declines were gains in the domestic volumes. New shorter haul services into and out of Atlanta and Marion, Ohio as well as the opening of a new terminal in Chambersburg, Pennsylvania helped drive a 15% increase in domestic traffic. These new domestic services will continue to be a catalyst for growth in the future.

Now lets take a look at the Intermodal operating income for the fourth quarter, Intermodal had a record fourth quarter profit of $77 million representing a 13% increase over last year’s fourth quarter. These results were achieved despite lower volumes as Intermodal continued its focus on the bottom line and cost control. Total costs decreased $9 million year over year despite higher fuel prices driven by greater efficiency and productivity including improved equipment utilization and expenses associated with lower volume. The combination of Intermodal’s top line actions and tight cost controls led to a 2.5 point improvement in operating ratio to a record 78.5% for the quarter.

Now let’s take a look at the revenue outlook for the first quarter of 2008. Of course fuel prices are high right now and if we back out the impact of fuel recovery our first quarter revenue outlook is still positive. With five markets viewed as favorable, three viewed as neutral and only two viewed as unfavorable. Yield management will continue to be the key driver across all markets as we continue to improve the value of our service for our customers.

Merchandise will see continued growth in agricultural products, chemicals, metals and phosphate and fertilizer. Coal, coke and iron ore revenues are also expected to remain strong due to the strength in the export market and the favorable pricing environment. Yield efforts should offset the volume losses in the automotive and emerging markets. Volume losses in the international segment of Intermodal should moderate and be mostly offset by gains in the domestic business. Forest products and food and consumer markets will see moderating losses as a result of the continued softness in the housing sector.

Overall we continue to see a favorable environment for the railroad industry despite the weakness in the housing and the automotive sectors. At the same time we remain committed to providing excellent service and value for our customers and we will not sacrifice price for short term volume gains.

Thank you and let me now turn the presentation overall to Oscar to review our financial results.

Oscar Munoz

Greetings and salutations to everyone as well. On slide 24 which represents our reported numbers we recorded earnings per share of $0.86 for the fourth quarter an increase of $0.11 from the prior year. Starting at the top of the slide and working our way down, as Clarence mentioned, we have seen nearly six years of uninterrupted top line growth as our strong service product and our focus on yield management drove the $181 million improvement for the quarter.

This increase was the primary driver in delivering surface transportation operating income of $609 million reflecting an improved operating performance and this team’s focus on delivering continued improvement in our financial results. Moving below the line other income increased $14 million primarily reflecting higher real estate sales. Next line interest expense increased $16 million relating to an incremental billion dollars of debt issued in the third quarter. Finally income taxes are $82 million higher due to a prior year benefit and the increase in this years earnings.

If we turn to the next slide let’s look at our results on a comparable basis. After removing the gain on insurance recoveries and the prior year gain on conrail property and income tax benefits EPS was $0.85 in this year’s quarter versus $0.57 a year ago. Looking at operating income removing the gain on insurance recoveries for both years our Surface Transportation businesses increased earnings $123 million or 26%.

Now let’s review the key drivers for the quarter on the next slide. In the quarter we recorded a favorable adjustment in our personal injury reserves which was only partially offset by an increase in our environmental reserves. This favorable adjustment directly reflects significant sustained improvements we have made in reducing personal injuries. As depicted in the blue shaded area of the chart our earnings momentum remains strong despite a softer economy and significant fuel headwinds in the quarter. We delivered core earnings growth of $67 million over last year’s previous fourth quarter record of $478 million. This was driven by our continued focus on yield management and cost control. The combination of these two items drove our record fourth quarter comparable operating income of $601 million.

Moving to the next slide let’s look at the major components of expense. As you can see from the chart overall expense growth was driven by significantly higher fuel costs in the quarter. Total expenses were up 3% overall however non fuel expenses were down 2% versus last year. Drivers for the quarter were the company’s continued focus on productivity and efficiency and lower volumes.

Let’s review our expenses in more detail starting with fuel. Overall fuel increased 32% or $86 million versus last year. The primary driver was the $0.75 increase in the average price per gallon resulting in over $100 million of additional costs. This was partially offset not only by a decline in volume in ton miles but also by a continued focus on fuel efficiency. On the chart on the left fuel efficiency is measured by gallons per gross ton mile has been improving steadily over the last three years. In the fourth quarter alone this improvement resulted in $9 million in year over year savings.

On the next slide labor costs increased only 1% or $6 million from last year. We were able to hold costs basically flat as we continue to focus on right sizing our resources to existing business levels. These savings were offset by the effects of inflation and other employee benefit costs. Going forward we expect our labor and fringe expenses to increase less than inflation as we achieve our productivity objectives.

Moving on to the next slide MS&O expenses declined 6% or $29 million from last year. As I said previously the primary driver for this decrease was a favorable reserve adjustment of $56 million comprised of a favorable change in personal injury reserves partially offset by costs and environmental. As you can see on the chart on the left the uncompromising focus on safety by our operations team results in a 48% decrease in personal injuries over the last three years.

As a reminder we evaluate our personal injury reserves twice a year with the assistance of independent actuarial assessments analyzing historical and recent trends in claims and settlements. Partially offsetting this favorable benefit was the impact of inflation and the increase in costs related to the derailments in the quarter.

Let’s talk about rents on the next slide. For the quarter rents declined 9% or $11 million as inflationary costs were more than offset by the impact of lower volumes and by the improvements in equipment utilization. On the chart on the left payables days per load which measures the utilization of the freight cars where we pay rent improved by 5% from the prior year and by 13% over the past two years. These results are reflective of our continued improvements in operational fluidity.

Let’s finish with the remaining expenses on the next slide. All other expenses increased $6 million or 2% versus prior year. The driver of this increase was depreciation which was higher due to a net increase in our capital assets base. Mostly offsetting the increase are lower depreciation rates as a result of asset life studies completed during the year. Finally our inland transportation expense was driven higher by the growth in our domestic Intermodal traffic which resulted in an increase in trucking costs.

On the next slide, in summing up our performance for the quarter the combination of our continued focus on yield management combined with ongoing productivity improvements produced a comparable operating ratio of 76.7%. This continues our industry leading improvement of nearly 900 basis points over the last three years and as our best fourth quarter operating ratio in the last 10 years. While we are pleased with the progress we have made to date we are intently focused on our goal of achieving a mid to low 70’s ratio by 2010. That finishes our fourth quarter review.

Let’s turn to slide 34 and look at the full year. As Michael mentioned earlier 2007 was another successful year for the company. For the full year we again produced record comparable results with operating income improving 14% to $2.2 billion and earnings per share improving 22% to $2.70. However the real story is the three year progression of the company’s financial momentum. Over this period operating income has more than doubled and earnings per share have nearly tripled reflecting the improved pricing environment and the over $400 million in productivity improvements delivered by this team.

As we move to the next slide this financial momentum has resulted in incremental cash flow. In ’07 we generated $145 million in total free cash consistent with our guidance of $100 plus that we gave our September investor conference. Our strong results in cash flow generation enables us to make three strategic decisions for the benefit of our shareholder. First, and as we mentioned in September we invested an additional $200 million to refinance existing leased locomotive capacity. Second, we made a significant pension contribution fully funding our major qualified plans in the fourth quarter. Third, we increased our dividends to share owners by 50% over this year and more than doubled them over the last two years reflecting our strong commitment in returning value to share owners.

This commitment is also reflected in our current $3 billion share repurchase program that we can walk through on the next slide. During the fourth quarter we repurchased $565 million or just over 13 million shares of our common stock. To date we have completed 70% of our $3 billion program and we remain on track to finish the program this year. Over the last two years including previous share repurchase programs the company has bought over $2.6 billion of outstanding common stock representing over 65 million shares. As we demonstrated we will continue to have a balanced approach in the use of our free cash between reinvesting in our business and providing direct value to our share owners through dividends and share repurchases.

As you can see on the next slide this balanced approach in returning value to our share owners is based on the high level of confidence that we have in the future of our company in this evolving transportation marketplace. As a reminder, through 2010 the company will be producing double digit growth in operating income and earnings per share off this record 2007 base. At the same time the company will drive it’s operating ratio to the mid to low 70’s and produce free cash flow before dividends approaching the $1 billion mark by 2010.

With that let me turn it back to our Chairman, Michael Ward for his remarks.

Michael Ward

Those of you that have been with us for the last three years have seen your share value rise by 120% that’s better than our peers and better than 90% of the S&P500. We’re creating that value by leveraging the resiliency of our industry and combining that with even stronger operations. This team has reduced the company’s operating ratio by nearly 900 basis points over the past three years to its best level in a decade. This success is due to top line growth and aggressive process improvements which have produced more than $400 million of savings over the last three years.

Over the next three years we will drive even greater efficiency as we target a mid to low 70’s operating ratio by 2010. At the same time we must and will make strategic targeted investments to capitalize on the growth potential of our industry. Long term debt potential is driven by growing and shifting populations increasing global trade and traffic congestion on the highways. Near term we will build on our momentum to again deliver record results for 2008.

For this team it’s not enough to just participate in the rail renaissance we want to lead it by creating a 21st century freight transportation network that is best in class. As I said before you cannot and should not underestimate the importance of this critical service we provide to the country. This means that we have to be responsive to the safety, security and economic needs of the nation. That takes investment, discipline and dedicated employees, we have all three.

By just about every measure of safety, service and financial performance your company CSX is the fastest improving company in an extremely attractive industry. Today, in fact, we rank among the industry’s best in safety and service and have created more shareholder value than any other railroad over the past three years. We are going to continue on that path and along the way we will become the best company in more and more categories while remaining relentless in our pursuit of excellence across the board.

With that we’ll take your questions and ask that you please identify yourself and your affiliation for the benefit of all the participants on the call.

Question & Answer Session

Operator

The first question comes from Tom Wadewitz with J.P. Morgan.

Tom Wadewitz – J.P. Morgan

Definitely impressive results this morning so congratulations on that. I wanted to understand a little bit in terms of your conviction and visibility on the pricing outlook for 2008 if you could just give a sense of how much of that is already locked in or carry over from 2007 and how much is still you need to go out and fight for and get put into contracts?

Clarence Gooden

We remain pretty confident in our ability to achieve the 5% to 6% pricing gains in 2008 that we told you about. Long term we think we can keep our price above inflation that’s reflecting the value of the service we got on our plan for next year 2008, for this year, traffic that’s either rolled over or we already have contracts signed on is somewhere in the neighborhood of 69% of the number that we expect to achieve.

Tom Wadewitz – J.P. Morgan

In terms of the cost side of the equation Tony or Michael I was wondering if you could give a sense of how much of the headcount reduction came from the TE&Y the 3.5% headcount reduction in fourth quarter and how sensitive is that to volume growth in terms of our outlook for 2008 on headcount reductions?

Tony Ingram

Your observation is right it was in the T&E side and a lot of this was somewhat we got ahead of attrition a little bit and the other was part of our improved operation and being able to reduce people on some of the jobs according to our agreement. We hope to get this work done before the half of the year is over with and get these people back to work as attrition comes in and that headcount should stay pretty stable through the year.

Tom Wadewitz – J.P. Morgan

If volumes were flat in ’08 would you still see headcounts down year over year driven by things outside TE&Y or if volumes were flat would headcount be approximately flat?

Tony Ingram

At this point it will probably be about flat but if we had some pocket areas where the business did go down obviously we would reduce in that area. We would follow the trend if business went away or got weak in some markets then we would reduce more.

Tom Wadewitz – J.P. Morgan

Oscar on the MS&O line if you add back the $56 million in P&I and I’m not sure if its fair to add all that back but if you do it looks like the inflation is relatively high in that line about 9% which I just wondered if you could give a sense for what’s driving that and what the right way to look forward at that line is?

Oscar Munoz

If you were to adjust, for instance, that whole reserve amount I think that takes you about 20 or so above kind of what a normal run rate that you’d expect. I’d attribute it in the fourth quarter to the couple derailments that we had. I think it’s about the size of those two issues and that’s the primary source of that increase. In going forward as you know the MS&O line is one that fluctuates between the business operations day to day and all the risk and safety related items that go in there. Clearly we continue to drive that one down as well.

Tom Wadewitz – J.P. Morgan

The derailments were $20 million in costs?

Oscar Munoz

Yes, roughly.

Operator

The next question comes from John Barnes of BB&T Capital Markets.

John Barnes – BB&T Capital Markets

In looking at some of your comments on the volume outlook in ’08, two areas; number one on the coal side can you give us an idea from domestic coal outlook where inventory levels with utilities on your lines are you expecting an improvement as the year goes on or do you expect volumes to kind of be flat here on the coal side? I’m looking for more of a progression through the year in ’08.

Clarence Gooden

As I mentioned the utility coals are pretty much at their target levels so in both the North and the South. Excluding any super hot weather this summer, instead of building those inventories they are maintaining those inventories and we expect those to be relatively flat. With regard to export coal, export coals is a very strong; they’re strong both over Newport News and over Baltimore Piers. We expect those to remain strong, stronger than this year, throughout the coal market season of 2008.

John Barnes – BB&T Capital Markets

On the Intermodal side is there any material piece of business up for renewal either domestic or international or new piece coming online that would influence the volume trends in 2008?

Clarence Gooden

I think our volumes are going to be slightly flat to down for the first quarter and as a result some of the lower international volume, some of the losses that we had in the international volume but we have some new products that we’ve put in place. One is between Charlotte and Florida, the Chambersburg market is growing for us the Marion market is growing for us. We picked up new volume on the VNSF services into Atlanta. We think that the domestic side will start to offset some of that weakness in the first half and we expect Intermodal to grow in the second half.

Operator

The next question comes from Scott Flower of Banc of America Securities.

Scott Flower – Banc of America Securities

A few questions for Clarence, just trying to get a sense on fuel surcharge coverage stayed about the same or has it improved, I’m just trying to get a sense of where you are on coverage?

Clarence Gooden

We’ve actually improved a little bit; we are at coverage of some sort of fuel surcharge pricing mechanism of about 90% of our traffic.

Scott Flower – Banc of America Securities

I’m just curious, versus third quarter, because obviously I’ve read through the flash and there are moving parts and pieces, versus third quarter did mix help you, about flat and was it basically the delta between your same shipper price and what happened to RPU mainly fuel or did mix negatively or positively impact that?

Clarence Gooden

Mix positively impacted it but only by a small amount.

Scott Flower – Banc of America Securities

So it was comparable to third quarter?

Clarence Gooden

I’d say that was true.

Scott Flower – Banc of America Securities

One other question for you and then I had one for either Mike or Oscar. Export coal obviously with robust demand and that’s on April pricing cycle are you anticipating that when we look toward that timeframe that those markets will see nice yield gains?

Clarence Gooden

Yes I do, as you mentioned that market runs from April to March so at least through March of 2009 we expect export coal to remain strong.

Scott Flower – Banc of America Securities

I mean in terms of the yield side.

Clarence Gooden

Yes sir.

Scott Flower – Banc of America Securities

One quick one on the reserve side, obviously you all have had a multi year improvement in safety and that gets into how the actuaries look at your reserves. Are you trued up now or how should we think about that going forward? I know that in second quarter you obviously had a good reserve adjustment relative to past performance and then obviously now. Are we sort of at the run rate or is there still room for further reserve adjustments as we look into ’08?

Oscar Munoz

I guess the best way to look at it, you have it right, it’s a frequency and a severity issue and both of those have been improving mightily and as Tony outlined in his part of the presentation. Over the course of the last two, three years we have been accruing at a higher rate given our previous experience and so the reserve adjustments that you’ve seen are sort of a reduction of those P&L hit that we’ve taken over the last couple of years. As to your question are we trued up and such, you don’t know, our trends and our record will be continuously monitored every couple of years but we would expect that the magnitude of those changes would probably lessen in the future.

Scott Flower – Banc of America Securities

When you talked about, I think it was roughly $56 million was a reserve adjustment, is that net of the environmental or is the environmental separate from that?

Oscar Munoz

It’s net.

Operator

The next question comes from Ken Hoexter of Merrill Lynch.

Ken Hoexter – Merrill Lynch

Clearly a rough day to post some pretty great results. On the fuel side can you talk about could we see any carry over to the first quarter? Was there any lag on fuel recoveries that you didn’t get that you think are going to catch up in the first quarter? Could we see another benefit in the first quarter from this?

Oscar Munoz

As you look forward here into the first quarter unless you have a better crystal ball as to the price of fuel as you know if it stays roughly the same its one outcome if it decrease it has one outcome. We just look out on the forward curve and base our assumptions that way.

Ken Hoexter – Merrill Lynch

I guess what I’m getting at is there is no, if fuel were to have held steady obviously its down this morning but if it holds steady is there some sort of catch up that because of the run up in fuel toward the end of the quarter I guess is what I’m asking?

Oscar Munoz

To your point, if it stays steady there wouldn’t be much.

Ken Hoexter – Merrill Lynch

On the Intermodal side obviously we’ve seen a huge shift to more and more goods moving East. Does that ultimately is that where a large part of that lost volume is coming from or when you look at the volume is there something else going there because obviously the poured volumes are slow but not as large of negative at the international slow down?

Clarence Gooden

No, as we mentioned earlier, earlier in the year 2007 we lost a couple of international accounts and that’s impacted that volume.

Ken Hoexter – Merrill Lynch

Are those lost to other rail or is a lot of that now going truck? What percentage is now going truck versus?

Clarence Gooden

It was lost to other rail.

Operator

The next question comes from William Greene with Morgan Stanley

William Greene – Morgan Stanley

Can you give us some color on 2008 capex and also not just the number but how you could or what would cause you to sort of flex it up or down, what’s the thought process there?

Oscar Munoz

The number you know obviously and the components are consistent with what we’ve done this year and what we outlined in September and your second question obviously we will continue to reevaluate market and regulatory conditions as time goes on. At this point in time we would not see any change to the numbers that we mentioned just a couple months ago.

William Greene – Morgan Stanley

How much flexibility do you have around the number? If volumes disappoint is it $50 million, $100 million that could drop it or is it pretty much locked in for full year regardless.

Oscar Munoz

We’ll always reevaluate given market and regulatory conditions we have flexibility anyway we please but we are pretty committed to the numbers that we have in 2008.

William Greene – Morgan Stanley

Clarence if can I ask you just for your views on the volume numbers, do you have a sense for when we’ll actually see them finally start to turn positive in aggregate?

Clarence Gooden

It’s kind of hard for me to say in total given the market conditions, the automotive and the housing sectors are down. I would tell you that we’d have positive numbers in our agricultural products, we should have positive numbers in our coal, we’ll have positive number in our phosphates and fertilizers, our metals markets right now looks like in the first quarter here is going to stay reasonably strong, our chemical markets are sort of flat as we were given the guidance at the end of the presentation. Until the housing and automotive sectors come back in a big way, because there are so many components that are tied into those product lines it’s difficult to say when everything in totality is going to rise.

William Greene – Morgan Stanley

On the Legacy contracts that might not have been touched yet, what percentage are you at now?

Clarence Gooden

We are at 15% and in 2008 we should re-price about half of those.

Operator

The next question comes from Edward Wolfe of Bear, Stearns.

Edward Wolfe – Bear, Stearns

Just a follow up, how do you get 15% that haven’t re-priced but you are only 10% now on fuel that isn’t getting a surcharge? What’s that 5% that are getting a fuel surcharge but haven’t re-priced?

Clarence Gooden

Transactional business.

Edward Wolfe – Bear, Stearns

Can you talk about the net fuel impact in the fourth quarter? You talked about the extra costs and the $18 million of being more efficient can you talk about how much the revenue was up year over year?

Clarence Gooden

In which area was that again please?

Edward Wolfe – Bear, Stearns

Fuel surcharge, I’m trying to figure out the net fuel impact in the quarter.

Oscar Munoz

I think you’re asking more of a financial question I think. You saw the 86 on the net fuel. I would say the lag impact offset and reserve probably half of that in the 40ish the lag impact in the quarter.

Edward Wolfe – Bear, Stearns

Export coal, can you talk to how much your total volume rate now consists of export coal and what the capacity is if you have a strong market near where that can get to?

Clarence Gooden

Right now our best guess is that export coal this year will be about 30 million tons 30.5 million tons. We know we have the car capacity for that we brought the cars on, we’ve got the locomotive capacities in place and the crew capacity are in place to handle that. We’ve been through this on several exercises with our coal supplier so the coal supply is there and the contractual agreements are in place. The biggest issue in my view that we are going to have in the export coal markets could be potential bottle necks at ports. We had been in constant discussion with the four major coal pier operators on the East coast that will be handling that volume. They’ve assured us that they are able to handle it; they have increased the maintenance at their facilities so we feel pretty comfortable right now being able to handle that volume.

Edward Wolfe – Bear, Stearns

That’s 30 to 30.5 you are talking about 2008?

Clarence Gooden

That’s right.

Edward Wolfe – Bear, Stearns

Where were you in ’07?

Clarence Gooden

About 19 to 20 million.

Edward Wolfe – Bear, Stearns

Separately, metals how do you expect metals to stay up if auto and housing is so weak? Is that something that is up right now but probably unless we get an improvement in those doesn’t stay up or is there something driving that?

Clarence Gooden

The United States consumes about 130 million tons of steel on an annual basis just about year after year after year. We produce somewhere in the neighborhood of 105 million tons of steel here in the United States. As our steel demand declines and given the fact that most steel companies are now on a worldwide basis, imports is what actually declines coming into our country, number one point. Number two is steel demand in China is still fairly strong and we expect it to stay strong through the Beijing games this year. The third factor is in our steel industry to date, pipe is being used in the oil industry and in the natural gas industry is literally booming right now at an all time high. For this year we expect US steel to remain fairly robust.

Edward Wolfe – Bear, Stearns

Can you talk a little bit back towards the depreciation and the change in the asset life studies? There was a large one that you did in second quarter it sounds like a smaller one this quarter on the Intermodal side. How should we think of what $882 million in depreciation would have been under the old schedules in ’08?

Oscar Munoz

Probably the best way that I would suggest go forward aspects of this would be to take the fourth quarter overall number and then apply your models with the incremental capital that is going to be spent next year. I think with that you should be fine.

Edward Wolfe – Bear, Stearns

In other words this is an ongoing number and then on a go forward base taken depreciation based on capital spending.

Oscar Munoz

Capital expenditures, there will be some minor issues but they are very small in nature.

Edward Wolfe – Bear, Stearns

In other words you don’t expect a grandfathering issue to when we get there to make a difficult comp?

Oscar Munoz

No.

Operator

The next question comes from John Larkin of Stifel, Nicholaus

John Larkin – Stifel, Nicholaus

A couple of questions, somebody asked about the Legacy contracts that are still out there and I think you mentioned about half of the 15% that have not been marked up to the market will be re-priced in ’08. How does that tail look beyond ’08?

Clarence Gooden

It stretches out in some cases 2012 and 2013 and there’s very limited exceptions to that, they tend to be smaller contracts but it’s on out a few more years.

John Larkin – Stifel, Nicholaus

So ’09 is going to be quite a bit smaller in terms of re-pricing than ’08 will turn out to be?

Clarence Gooden

Two thousand nine will be smaller from re-pricing Legacy contracts but not from re-pricing in general.

John Larkin – Stifel, Nicholaus

Tony had mentioned that fuel had taken about 3.5% of the workforce out presumably those people are on furlough and then he went on to talk about how attrition ought to allow those people back to work. My question is as we get out into the second half of this year presumably your year over year volume comparison start to turn positive as I think somebody mentioned a few minutes ago and as you look into let’s say ’09 we get back to let’s say something like a two or a three or four percent tonnage growth curve presumably you are going to need to add more people to accommodate that growth? How early if you in fact have brought all your experienced people back to work do you have to start hiring additional people and training them? When might those expenses start filtering through the income statement?

Clarence Gooden

It usually takes us four to five months to get our first level employee in place and as the attrition goes through the year stays on target with our model and as our business stays on target we’ll look at those toward the end of the year.

Oscar Munoz

If I could just add something to that. As you walk through your scenario the only thing that I would adjust a bit at your discretion is the previous history of how many people for how much volume is a model that I think Tony has been changing. I think as you see the adds in overall headcount for the volume that we’ll see in the future it won’t be at the same level that you would have expected before. In essence would be more productive and efficient so it’s a note in the future.

John Larkin – Stifel, Nicholaus

On the phosphate fertilizer and Ag product side which were very strong for us in terms of volume and in terms of yield. My sense is that most of the ethanol business is concentrated in the mid-west but that that could be shifting perhaps somewhat down into the Southeast as that trend continues. Can you talk a little bit about how that might benefit CSX and what we might expect to see over the next couple of years in those markets?

Clarence Gooden

You are correct most of the plants in the ethanol business are located, the vast preponderance of those plants are located in the Midwest. Where we’ve seen growth has been across New England states and some of the Mid-Atlantic States. We are now starting to see growth come into the Southeast and most of that growth is coming into the Southeast is coming in the form of the refined ethanol. We only have one major ethanol producing plant that is located in the Southeast that’s in Camilla, Georgia and we would expect to be in a position to haul both inbound product corn as well as ethanol out of that facility.

John Larkin – Stifel, Nicholaus

There are no other additional plants on the drawing board in the Southeast?

Clarence Gooden

We have some that are on the drawing board but what you are going to find is the principle preponderance of those plants will stay in the Midwest because of the proximity of the corn, the availability of water supplies.

John Larkin – Stifel, Nicholaus

Were there any comments up front on capital spending, any changes in the thinking there with respect to the slow start that we are off to volume wise in the year?

Oscar Munoz

There were no changes to the guidance that we’d given for ’08.

John Larkin – Stifel, Nicholaus

Did Michael mention anything regarding the company’s strategy to respond to the proxy battle that’s been mounted against the company?

Michael Ward

At the beginning of the call, it’s unfortunate you missed it we said our call today is really about the fourth quarter and year end results and really communications around that are tight proxy rules.

Operator

The next question comes from John Kartsonas of Citigroup Investment Research.

John Kartsonas – Citigroup Investment Research

Once again you redirect your guidance for the next few years here and day after day the economic odds are bigger and bigger. Can you give us an idea what the sensitivity of this guidance is in the economic environment and what are the chances that one day we wake up and this cut because of a slow economy or so?

Oscar Munoz

We wake up everyday and we look at everything as you might expect and then as is the history of this company a lot of our guidance is always very thoughtful in the long run with regards to wavering economic conditions and so again we revaluate everything but as we speak now, every time the reason we reiterate that guidance every time we have a chance to is that our forward plans continue to show that kind of growth potential in this great transportation environment. The sensitivity is obviously is to a degree the economy but we've shown a lot of resiliency. It's I think a year ago at your conference we established a pretty firm point that not only CSX but the industry would obviously grow financially through this cycle and we've proven that and I think that resiliency and the diversity of the portfolio continues. Again we re-look at it every time we wake up and we feel confident once again at a rate that same guidance.

Operator

The next question comes from Jason Seidl from Credit Suisse.

Jason Seidl – Credit Suisse

First question, maybe this is for Clarence. How much of your 2004 rail renaissance renewals that you had in pricing, what percent are they under today’s market rate right now?

Clarence Gooden

I’m not sure I know the answer to that question. What percent are my 2004 rail renaissance rates under market rate?

Jason Seidl – Credit Suisse

Right, because 2004 is really the first full year that you guys had the renewed pricing power but how much are those 2004 rates already below market rates right now?

Oscar Munoz

We are having a hard time understanding your question.

Jason Seidl – Credit Suisse

In other words, when you took your price increases in 2004 that was really the first full year that you guys had pricing power. Those rates that you increase in 2004 how much below market are they right now as we are sitting here in 2008? They might now be Legacy renewals but as they renew how far below true market rates are the ’04 rates?

Clarence Gooden

Probably double digits.

Jason Seidl – Credit Suisse

Can I concentrate a little bit here in Intermodal now? Your domestic was strong, obviously you had a couple new service offerings open up in the quarter but if you “x” out those new service offerings what was your same store sales in Intermodal domestic grow?

Clarence Gooden

It’s difficult to say in that because if “x” those two services out I had additional services through our brokerage and load board moving in. We had same store sales RPU’s moving up in Intermodal. The biggest issue in Intermodal is the loss of international traffic.

Jason Seidl – Credit Suisse

Can you guys give us an update on the Maersk port and how much business you are seeing from that?

Clarence Gooden

We are seeing very little business from Maersk port. You are talking about the one up at Norfolk right?

Jason Seidl – Credit Suisse

Right.

Clarence Gooden

Very little, we have access, we do some business but not large quantities.

Operator

The next question comes from David Feinberg – Goldman Sachs

David Feinberg – Goldman Sachs

Two questions on Intermodal; first can you just remind us with regard to the contract losses that you referenced earlier when we’ll begin to lap those in ’08?

Clarence Gooden

Yes, we’ll start to lap those by the end of the first half.

David Feinberg – Goldman Sachs

You’ll start to or you’ll finish lapping them?

Clarence Gooden

We’ll complete.

David Feinberg – Goldman Sachs

Just a general question, on the lanes that you serve that are competitive with trucking can you give us a general sense in terms of what the pricing differential is between truck and rail Intermodal shipments whether it be domestic or international today?

Clarence Gooden

It depends on if it’s domestic it depends on if its international and it depends on if its premium. We are very competitive meaning we are close to trucks on any type of international moves that are moving over the highway. We are very close and very competitive with truck on a door to door basis on regular everyday domestic traffic. We are priced under what premium trucking is getting.

David Feinberg – Goldman Sachs

When you say priced under is that a 10% discount is that a 50% discount, can you give us?

Clarence Gooden

It would be in the 10% range.

David Feinberg – Goldman Sachs

One question on labor, when we look at some of the temporary labor agencies that we also cover, workers compensation expenses, that tends to be cyclical and what happens is during times of economic weakness workers comp and other related employment insurance increases that follows year over year improvements during periods of economic expansion. CSX safety initiatives aside, based on the previous economic cycles that you’ve lived through, are the MSO reductions that you’ve achieved in recent years could you see those reserve reductions slow and or reverse themselves if we go into a recession?

Michael Ward

We are under FILA so the experience under FILA is different than what you see under workman’s comp and its probably much more steady state given the age profile of our industry.

Operator

Our last question comes from Ken Hoexter – Merrill Lynch

Ken Hoexter – Merrill Lynch

I wanted to come back on a bigger picture question. Any update in Washington that you’ve seen as far as the status of the few bills that have been progressing as we enter the election year?

Michael Ward

As you know one of the big things we are very interested in is the investment tax credit which had 57 House of Representative sponsors and 16 in the Senate. We think there’s a growing realization that there’s a need for rail infrastructure in this country. We think that is going to continue to gain momentum next year but I guess the real challenge is some of the pay as you go rules make it a little more challenging but I know you’ve seen the recent study where the National Service Transportation Policy and Revenue Study came out and supported that rail infrastructure tax which we think is very encouraging.

On the re-regulation side I think obviously there’s more discussion out there, I think we still are of a view that the policy makers in DC when they get done evaluating the value we can bring to solving the infrastructure and environmental issues of this country we’ll come out with balanced reasoned approaches which will not put us under the burden of heavy regulation going forward.

Ken Hoexter – Merrill Lynch

And on the safety?

Michael Ward

On the safety side I think as you know some of the rail security bills and safety bills I think we are able to adapt to them and actually quite supportive as we are very concerned with the safety of our employees in the communities we operate in. I think those are things we’ll handle in the regular course of business.

Ken Hoexter – Merrill Lynch

Just a quick follow up on the investment tax credit, is that being tossed into the debate right now about any of these bills that pushes proposing to further throw money back into society?

Michael Ward

I don’t think it’s got to that level of momentum yet.

With that it appears that our call is over, I thank you for your attention and your interest in our earnings. Thank you very much.

Operator

Ladies and gentlemen this concludes the conference call; we thank you for your participation in today’s call.

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Source: CSX Corporation Q4 2007 Earnings Call Transcript
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