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CSX Corporation (NYSE:CSX)

Q2 2008 Earnings Call

July 16, 2008 8:30 am ET

Executives

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

Tony L. Ingram – Executive Vice President & Chief Operating Officer

Clarence W. Gooden – Executive Vice President Sales & Marketing & Chief Commercial Officer

Oscar Munoz – Chief Financial Officer & Executive Vice President

Analysts

Ken Hoexter – Merrill Lynch & Co.

William Greene – Morgan Stanley & Co.

Thomas R. Wadewitz – J.P. Morgan

Edward M. Wolfe – Wolfe Research, LLC

David Feinberg – Goldman Sachs

Analyst for Gary Chase – Lehman Brothers

Matthew Troy – Citigroup

[Jason Sidel – Dahlman Rose]

Operator

Welcome to our second quarter earnings presentation. The presentation material this morning that we will be reviewing along with our quarterly financial report and our safety and service measurements are available on our website at www.CSX.com under the investor’s section. In addition, following this presentation a webcast and podcast replay will be available for your review.

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

Before we begin the formal part of the presentation this morning, 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 statements. With that, let me turn the presentation over to CSX Corporation’s Chairman, President and Chief Executive Officer Michael Ward.

Michael J. Ward

Once again our company has delivered record financial results. Today we reported record second quarter earnings of $0.93 per share. On a comparable basis excluding an income tax benefit that equates to an EPS of $0.89, up 25% from a year ago. Our strong earnings were driven by record revenues and operating income as well as our ability to sustain high levels of operating performance we have established over the past several years. Simply put, our company is strong, resilient and focused.

Our performance and safety and service over the past several years has been the result of continuous improvement and while we did not improve upon those results in the second quarter, our results were stable at the higher levels. As Tony will outline, the team is focused on increasing our performance from these higher levels in the near and the long term.

Revenues grew significantly as Clarence and his team continued to build momentum on two key factors: the ability to turn our high level of service in to pricing that reflects the true value we are creating and the ability to leverage our diverse portfolio to manage through the changes in the economy. In addition, as Oscar will discuss, our ability to manage cost and drive productivity improvements enabled us to maintain our core earnings momentum and achieve further improvement in operating ratio despite a substantial fuel headwind.

So, now let’s turn it over to Tony Ingram for a review of our operations.

Tony L. Ingram

You’ve seen this chart before, leadership, discipline, execution, that’s what got us where we are and will deliver results in the future. In the second quarter we were stable but did not deliver the kind of service improvements we expect of our sales. That said, we did see near record safety levels, we did continue to provide a high level of service to our customers and we did generate productivity to partially offset inflation and drive the operating ratio lower.

Now, let’s look at the results in more detail. On Slide Seven, you see our safety results. In the yellow box personal injuries were 1.25 for the quarter. The bars show our improvement at 1.22 for a rolling 12 months. Our personal injury frequency was higher and we’re not satisfied with this result. Our safety process is solid, we’re redoubling our efforts and we will return to the path of continuous improvements you’ve seen over the last four years. Looking at our train accidents, we had our safest quarter. Our performance improved for the quarter and on a rolling 12 months. This is a good story that will continue getting better.

Looking at Slide Eight, the dwell and velocity held fairly stable. In their terminals cars made the connection with consistency. For the quarter, the dwell was about 23 hours and that was better than last year. On a rolling 12 months, dwell also improved. It was a similar story on the line of [inaudible], velocity decline slightly to 20 miles per hour and held stable at 20.9 miles per hour on a rolling 12 months.

Let’s turn to Slide Nine to review our on-time performance. Overall, our on-time origination and arrivals declined for the quarter and for the rolling 12 months. The results were impacted by a surge in export coal that strained the network and by the Midwest floods that affect CSX and our interchange partners. That said, I’m not satisfied with these results and I expect improvements in at least as I said at the top leadership, discipline and execution. That’s what will get the job done and will deliver in more value for our customer.

Slide 10 shows our customer satisfaction rating. The score based on our quarterly survey by an outside group. As you can see, the rating remains at a high level. It’s better than the industry and close to trucks. Strong service is not only good for the customer but it’s also good for productivity.

Let’s turn to the next Slide. We’re on track to deliver over $400 million in productivity through 2010. We’re getting this productivity from all our key resources in the company. The network, you see that as the one plan, freight cars, terminal and fuel. We’re doing it in three ways: first, we continue to refine the one plan to match the change in business environment; second, our process improvement teams are planning and executing a pipeline of projects across all operating areas; and finally, total service integration is progressing on target, it’s improving the productivity and reliability of our service and creating capacity for growth.

In summary, our leadership to operate at a higher level and hold ourselves to higher standards. We will continue our momentum in safety and service and continue to provide productivity that will contribute to a lower operating ratio and greater financial results. Now, I’ll turn it over to Clarence to review the sales and marketing results.

Clarence W. Gooden

In the second quarter we again proved that creating value for customers in a free market environment is the best way to sustain a vibrant rail industry. Our results also show that revenue growth continues to be sustainable as our diverse portfolio and our focus on yield management has allowed us to offset the impact of the softer economy. This morning I will highlight our results and the primary drivers while offering some insights on what we see ahead for the remainder of 2008.

Now, let’s look at some of the results. CSX achieved another great quarter of revenue growth despite continued softness in the housing and automotive sectors of the economy. Revenues increased 15% to an all time record of $2.9 billion as yield improvements more than offset the impact of lower volumes. These yield improvements continue to reflect the value we are providing to our customers through consistent service. In short, secular strength and our diverse portfolio of businesses continues to generate revenue increases throughout the economic cycle as reflected in over six consecutive years of top line growth.

Now, let’s look at the revenue performance by market on the next Slide. Most of our markets experienced strong revenue growth for the quarter again, resulting from stronger yields, fuel recovery and volume growth in several markets. The only market segment that produced flat or lower revenues were those impacted by the housing and automotive sectors of the economy. In coal, agricultural products, phosphates and fertilizers and metals we produced significant revenue both on volume growth, stronger yields, a strong export environment, a stable industrial economy and growing demand for alternative fuels like ethanol. In chemicals and intermodal we also produced significant revenue growth as pricing gains and fuel recovery more than offset weaker volumes.

Now, let’s look at pricing on the next Slide. As we have reviewed with you in the previous quarters, the line on this chart highlights the year-over-year change in total revenue per unit which includes the impact of price, fuel and mix. During the second quarter overall revenue per unit increased 18%. The bars on the chart show the increase in price on a same store sales basis. This excludes the impact of fuel and mix. Same store sales are defined as shipments with the same customers, same commodities and same car types shipped between the same origins and destinations. These shipments represent approximately 75% of our total traffic base. Same store sales price increases were 6.4% for the quarter, consistent with the increases you’ve seen over the last three years. Based on the service and value that we are providing our customers, we expect that momentum to continue with pricing gains in the 6% plus range for the full year.

Now, let’s look at the major markets. Quarterly merchandise revenue increased 13% to $1.4 billion. This growth was driven by stronger yields in all markets. Revenues per unit increased 17%, more than offsetting the weakness in volumes which continued to reflect the impact of the softness in the housing sector and automotive related markets. We saw the most significant volume declines in our emerging markets, forest product and food and consumer markets due to lower shipments of cement, aggregates, lumber and appliances. In terms of revenue, six of the seven merchandise markets generated higher revenues with agricultural products, phosphates and fertilizers, metals and chemicals producing the most significant gains.

Turning to the next Slide, let’s review our results in coal. Quarterly coal revenues improved to $824 million. This is an increase of over 29%. Continued strong demand for export coal during the quarter offset declines in domestic utility volumes. In addition, the yield environment for coal continues to be strong with revenue per unit increasing 26% in the quarter. Price and fuel recovery were again the primary drivers. Going forward demand is expected to remain strong due to both the export environment and the growing need to replace utility stockpiles which are now below prior year levels.

Turning to the next Slide, quarterly automotive revenue of $205 million was 8% lower than last year. CSX’s volume was consistent with production declines in the second quarter as the slowing economy and tight credit conditions impacted auto sales. Higher fuel prices are causing a record transition from the SUVs to smaller vehicles. Producers are quickly reacting to the changing market with the big three plant closures being accelerated. However, pricing actions and fuel recovery resulted in an increase of revenue per unit of 19% which helped moderate the impact of lower volumes.

Turning now to our intermodal results, intermodal had record quarterly revenue of $385 million, up 12% versus last year as higher revenue per unit more than offset the lower volumes. In the quarter total volumes were down versus last year primarily as a result of the continued softness of the international market. Revenue per unit increased 14% in the quarter on higher fuel recovery and favorable mix. While the international market continues to be soft as slowing imports out of Asia combined with certain steamship lines redeploying assets to other markets, the domestic markets remain strong and volumes growing 12% over last year. Looking at intermodal operating income for the quarter, intermodal reported record second quarter operating income of $76 million. These results were achieved due to the continued focus on driving bottom line results through profitable revenue growth and cost control. As I mentioned, revenue growth was driven by strong revenue per unit gains which overcame softer volumes.

On the expense side we saw total cost increase driven by rising fuel prices reflected in inland transportation costs. Primarily mitigating these higher costs were productivity improvements and equipment utilization and greater labor efficiency. The net result was another record quarter of top line and bottom line results for CSX Intermodal.

Now, looking ahead to the third quarter, even when excluding the impact of fuel recovery, our revenue outlook remains positive. The outlook is favorable across six markets, neutral for two and unfavorable for the remaining two. Value pricing will continue to be the key driver across all markets as we deliver value for our customers through superior service. Merchandise will see continued growth in agricultural products, chemicals, metals and phosphates and fertilizers. 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.

In addition, intermodal revenues are expected to grow based on stronger yields, moderating volume losses in the international segment and continued strength in the domestic traffic. Revenues are expected to be flat in emerging markets and the food consumer markets as yield efforts are expected to offset continued volume softness. The outlook for automotive and forest products is unfavorable as we expect volume to more than offset the benefits from yield management.

In summary, as you can see in the pie chart on the right, markets with a favorable third quarter revenue outlook represents 75% of our traffic base so despite the weakness in the housing and automotive sectors of the economy, we continue to see a favorable environment for CSX and for the broader railroad industry in both the short and the long term. At the same time, we remain committed to improving yield reflecting the excellence service and value that we’re providing our customers. Thank you and now let me turn the presentation over to Oscar to review our financial results.

Oscar Munoz

On Slide 24 which represents our reported numbers we’ve recorded earnings per share of $0.93, up $0.22 from the prior year. If you start at the top of the Slide, revenues increased 15% to a record $2.9 billion. This revenue growth coupled with our ongoing focus on cost efficiency drove an all time quarterly record operating income of $717 million despite the headwinds from rising fuel. If you move below the line, other income increased $3 million versus prior year however, interest expense and income taxes are the bigger stories for the quarter. Looking at interest expense, you will recall that CSX issued an incremental $2.4 billion of debt over the last 12 months driving the $32 million increase year-over-year. As for income taxes, the $50 million increase reflects this year’s higher earnings partially offset by an $18 million tax benefit related to the resolution of prior year federal tax audits. Finally, the number of fully diluted shares outstanding is 44 million lower than last year reflecting the impact of our share repurchase program.

Now, let’s review the key drivers of our operating results on the next Slide. As you may recall, last year we had a favorable reduction to our casualty reserves of $34 million. In this year’s quarter we also favorably adjusted our casualty reserves by $15 million. So, on a year-over-year basis the net impact will be $19 million less favorable. Absent this impact, our core earning power as depicted in the blue shaded area of the chart increased $124 million or 20% consistent with the last several quarters and reflecting the continued strength of our business even in this more challenging economic environment.

This core earning momentum also translated in to better margins in our business. So, let’s take a look at our operational performance on the next Slide. The second quarter operating ratio improved to 75.3 despite a couple of issues: first, as mentioned on the previous Slide, the cycling of the year-over-year reserve adjustments impacted the operating ratio by 70 basis points; and second, the impact from the rising price of fuel on both our revenues and expenses added an additional 200 basis points. However, more than offsetting these two items was a 320 basis point improvement in our core business operations driven by our focus on yield management and cost control.

Now, let’s move on to the major components of our expenses. As you can see from the Slide on Chart 27, overall expense growth was primarily driven by the significant higher fuel cost in the quarter. Total expenses were up $272 million or 14% overall with $222 million being driven by fuel. However, non-fuel expenses were up only 3% versus last year primarily driven by inflation.

Let me begin a more detailed review of our expenses starting with fuel. Overall, fuel increased 70% versus last year. The primary driver was the $1.62 or 81% increase in the average price per gallon resulting in $222 million of additional cost. Slightly offsetting this impact was lower volumes and our continued focus on fuel efficiency. In the chart to the left, efficiency is measured by gallons per thousands gross ton miles has been improving steadily over the last three years. The second quarter improvement in locomotive fuel efficiency resulted in $9 million in year-over-year savings. In total, our efficiency improvements over the last three years have reduced our annual fuel consumption by almost 30 million gallons. The remaining variant for the quarter was driven by the increase in our non-locomotive fuel expense also reflecting the higher price of petroleum based products.

Continuing with our review of expenses on the next Slide, labor costs decreased 1% or $10 million from last year. Increases in wage and benefit inflation were more than offset by net productivity improvements of $32 million driven by the reduction in train crew headcount reflecting our focus on cost control. Going forward you can expect that we will continue to size our resources to meet business demands. On a full year basis, we expect our labor and fringe expenses to increase slightly but certainly less than inflation as we achieve our productivity objectives.

Now, let’s move on to MS&O on the next Slide. These expenses on Slide 30 increased 9% or $43 million versus last year. This quarter’s results were driven by three primary items: first, was our cycling of a net -$19 million increase in year-over-year casualty reserves that I previously discussed; second, there was an increase in cost for the proxy related litigation expenses; and third, were the normal impacts from inflation in the quarter. As you know, this line item has fluctuated from quarter-to-quarter driven by our material expense, safety performance, volumes and more broadly speaking our reserves, which can all have an impact on our results.

Let’s discuss rents on the next Slide. For the quarter, rent increased 5% or $5 million as lower volumes were more than offset by equipment utilization and inflation. The chart to the left shows payables and days per load which measures the utilization of the freight cars where we pay rent. As you can see from the gold bars on the chart, our total days per load degraded 15% versus last year reflecting the impact and significant decline in our automotive business. Excluding the automotive multi levels, our days per load performance was flat to prior year despite some of the operating challenges in the Midwest that Tony mentioned earlier. Looking forward, you should expect our rent expense to continue to move with our business volumes.

On the next Slide, let me review the remaining expenses. All other expenses increased $13 million or 5% versus the prior year. Depreciation was up $5 million as the net increase in our capital asset base was partially offset by lower rates from the asset life studies completed in the prior year. And finally, our inland transportation expense was driven higher by the increase in intermodal's transcontinental business and general inflation.

With that, let me update on how we are returning value to shareholders. On Slide 33, as you are aware we recently announced an increase in our quarterly dividend to $0.22 per share effective with the third quarter payout. This increase represents a more than tripling of the quarterly dividends since the end of 2005 and is driven by our growing earnings momentum. Over the long term, we will continue to target a dividend payout and yield that are competitive with our peers in the industry.

Now, updating you on our share buyback program, during the second quarter of this year, we repurchased an additional $151 million or almost 2.4 million shares of our common stock. Overall, since 2006 the company has repurchased over $3 billion of its stock representing almost 75 million shares and when combined with the remaining authority under our current program, we expect our total share repurchases to approach nearly $6 billion by the end of 2009. As we have demonstrated, we will continue to have a balance approach between reinvesting in our business and providing direct value to our shareholders through dividends and share repurchases.

Let me wrap up, the second quarter was another record quarter for CSX which combined with our first quarter performance generated a first half comparable earnings per share of $1.69. Based on these results, we continue to target the high end of our full year EPS guidance range of $3.40 to $3.60 per share on a comparable basis. This guidance clearly reflects a strong back half of the year driven by the fundamental strength of our businesses: first, with the continued strength in pricing we expect same store sales price growth of 6% plus for the year; second, continued cost control through our various productivity initiatives such as total service integration will help offset the inflationary pressures; and finally, our diverse business portfolio is enabling us to grow throughout the current economic cycle.

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

Michael J. Ward

I guess the best way to summarize our view of the quarter is this, we’re really encouraged by the continued strong performance and we’re relentlessly focused on continuing to improve our company to capture the vast opportunities we see over the next decade. Another record result in the second quarter and our strong expectation for a record result for all of 2008 is just the beginning. We’re driving aggressive goals that begin with industry leading safety, exceptional customer service and operational excellence and we will never let up in those areas.

As we discussed today, we have a firm foundation in place and a team that has proven itself time and time again. Safety, service, productivity and pricing strengthen our top and bottom line and result in true value for our customers and our shareholders. And, this performance must come from a business that is inherently able to drive financial growth through the economic cycle. Not long ago we anticipated the secular potential of our industry. Today, it’s here largely due to the growing value of rail transportation services and our efforts to meet the changing needs of our customers. Over the long term, secular strength comes from a growing population that’s consuming more and more goods and with the competitive advantages of our industry improving, more and more of those goods will be transported by rail.

For example, our competitive fuel advantage is more pronounced than ever particularly if you assume that oil prices won’t return to $50 a barrel anytime soon and the congestion on our highway system is something you’ve probably encountered on your way to work today. For these reasons and more, we expect to continue delivering strong results for our shareholders. We have a market environment that overwhelming favors the service we provide and a company that is capitalizing on that opportunity with solid strategy, dedicated people and strong execution. The team is delighted to be able to share these second quarter results with you today even as we’re working hard at delivering on the third quarter needs of our customers and another record quarter for our shareholders.

So, with that we’re pleased to take your questions.

Question-and-Answer Session

(Operator Instructions) Our first question comes from Ken Hoexter – Merrill Lynch & Co.

Ken Hoexter – Merrill Lynch & Co.

If I could just follow up on the pricing commentary, it sounds like you’re targeting 6% plus, it use to be 6% to 7%. I’m wondering if that has anything to do with the recent rate case or are you kind of just looking at what is going to renew in the second half of the year and looking for just a touch softer?

Oscar Munoz

Given that I usually give that guidance, I’ve said 6% plus pretty consistently so I’m not sure where the 6% to 7% is coming from?

Michael J. Ward

We actually started the year saying it was going to be in the 5% to 6% range.

Oscar Munoz

And then it went to 6% plus in the last quarter so you may have heard that some other place but not from us.

Ken Hoexter – Merrill Lynch & Co.

Now that the proxy vote is over you still haven’t released the results. Are we still waiting until the 25th to hear that? Then I guess what I really want to understand though is what happens now? When does the new board meet and kind of how does it progress from here to see kind of timeline of events there?

Clarence W. Gooden

Let me clarify a little bit there, we don’t release the results, actually there’s an independent proxy examiner that is doing that work and we expect that preliminary report of that independent inspector sometime soon in the next day or two, actually. As you know thought, those are the preliminary results and they are subject to the customary review and the normal challenge period as well as the outcome of the appeal that we have on the vote. As you know, we filed an appeal of the Judge [Kaplan’s] decision, that process actually some of the original filings have occurred, the initial briefs on July 3rd. There will be additional briefs filed later this month and there are oral hearings on August 25th. So, until we fully work through all of that Ken, I don’t know we will know the final results of that election.

Ken Hoexter – Merrill Lynch & Co.

Then pricing, I’m just wondering, it was very strong sequentially at coal, auto and intermodal. In other words, I’m guessing they have the ability to move pricing pretty quickly with the rise in fuel surcharge but some of the other products, when you look at phosphates, metals, food and chemicals on a sequential basis didn’t run up as much so I’m wondering, I don’t know, Clarence is there any kind of difference in the ability to capture fuel surcharge by those products specifically?

Clarence W. Gooden

Not really Ken, it just was the way it landed in this particular quarter.

Ken Hoexter – Merrill Lynch & Co.

Then just a technical question, Greenbriar was negative, is there something in that contribution there?

Oscar Munoz

No. Greenbriar has had a couple of quarters and so nothing out of the ordinary.

Ken Hoexter – Merrill Lynch & Co.

Then last question, on the domestic and international traffic, just in the division because it’s gotten so extreme, should we continue to expect domestic traffic to grow at that double digit rate, international to decline at the double digit rate? I’m just wondering what your outlook is on those specifics.

Clarence W. Gooden

Well Ken, your guess is probably as good as ours on that. The international traffic we think will remain soft for the rest of this year. Now, whether or not it will be in the double digit area, I’m not sure. But, you can expect to see our domestic traffic to continue to grow at those rates that you’re seeing now.

Operator

Our next question comes from William Greene – Morgan Stanley & Co.

William Greene – Morgan Stanley & Co.

I just wanted to ask on the DuPont case, did that outcome surprise you and does it change your strategy?

Michael J. Ward

It really doesn’t change our strategy. As you know, the SCB did come out there and that’s the first shipper case they have seen and as you know, those are designed to resolve disputes on small amounts of traffic. So, that said, we have appealed the SCB decision on several grounds but we think the SCB is being responsive to shipper concerns on these small shipper cases and I think that actually further demonstrates that the currently regulatory environment is working. So, while there’s always going to be that dynamic tension between the SCB and the railroads, we continue to see that we’re going to be able to price our services for the value we’re providing and to reiterate, we are expecting that the pricing will continue to be in that 6% plus range for this year.

William Greene – Morgan Stanley & Co.

If we turn to export coal, there was some speculation recently that your export coal rates were weakening. Can you talk about the dynamic of how you price? Is it related to the underlying commodity? How often do you reprice export coal?

Clarence W. Gooden

We reprice our export goal usually on the steam side in January of each year and on the metallurgical side in March of each year. I’m not aware of any rates that are fundamentally weakening in export coal. In fact, as we get new requests for pricing on export coal, they’re actually going up not going down. We expect export coal to stay strong at least through 2010 so we see a very strong pricing environment for export coal.

Michael J. Ward

I think we did hear some backing off of what the coal prices might be but, the rail rates have continued to increase.

William Greene – Morgan Stanley & Co.

Then just lastly, the $400 million of productivity you say, how far along are you in achieving that? What’s the run rate now?

Tony L. Ingram

I’m not sure we talked about that publically. I’m looking at David so I think the best way to think through that is from a ratable perspective over three years a good enough rate for you to use.

Operator

Our next question comes from Thomas R. Wadewitz – J.P. Morgan.

Thomas R. Wadewitz – J.P. Morgan

Let’s see, I wanted to get your thought, I guess Clarence or Michael, in terms of the risk you would have if the economically sensitive segments really rolled over further. I know you highlighted pretty well that 75% of your book has a positive revenue outlook. But, what do you see in terms of the more economically sensitive segments? Is there stability now? And, if the economy rolled over a bit further, how would you view your risks in terms of volumes and performance related to that?

Clarence W. Gooden

Tom, if I understand your question correctly, our current view is this; if it’s commodity related, it’s strong for us. If it’s in our domestic intermodal product, it is strong for us particularly given the fact that truck cost and just fuel cost are $0.80 a mile. On the automotive side and the housing side, we see what you see, it is weak, we expect it to continue to be weak for the rest of this year. We don’t see any kind of rebounds in the housing market or rebounds in the automotive market but the other segments of our business we find quite strong.

Thomas R. Wadewitz – J.P. Morgan

So the GDP numbers in the second half look like they would be weaker than as expected there probably wouldn’t be a lot of sensitivity in terms of what your outlook would be in terms of volumes and revenue? Is that fair?

Oscar Munoz

As you can guess, as we look forward not only for the balance of the year but through our 2010 long range plan, all those broad macroeconomic indicators are something that clearly goes in to our calculus in regards to that and so I think from a bottom line aspect, our full year guidance that we’ve given is still very solid with understanding all those various factors as well as our longer term guidance as well. So, I think there’s enough diversity in our portfolio, I think the solid foundation of service allows us to both price and be productive. I think the combination of those things have always been the drivers in our business and will continue to drive those numbers so we keep very close eyes on those things. But, at this point in time, no we don’t see any market changes to the things we’ve told investors.

Thomas R. Wadewitz – J.P. Morgan

It seems like the segments that are weak have been pretty beat up so it’s hard to imagine them getting a lot worse. So, thoughts on pricing you talked about this year, any sense of looking a bit beyond this year in terms of 2009, 2010 whether we should expect some slowing from that 6% rate or whether it’s feasible that you might stay around that level for another year or two.

Clarence W. Gooden

We see our pricing Tom going in to 2009 and beyond to be very favorable from a historical perspective.

Michael J. Ward

But we’re not giving specific numbers out. We think it’s going to be certainly well above inflation but what that number is depends on what the markets are and I think as we get closer to 09 we’ll be able to give a better read on that Tom.

Thomas R. Wadewitz – J.P. Morgan

Then I guess on the headcount reduction continued to be pretty good. It actually accelerated a little bit on a year-over-year basis, I think, to 3.7%. Is that trend, can you keep that going or do you feel looking out a quarter or two maybe you get a little too lean in terms of what the operating crews might look like?

Tony L. Ingram

I think as you look in the back half of the year if you think of business levels and some of the markets that Clarence mentioned, coal, intermodal in particular, if you think of our attrition programs, I think you’ll see a stabilization of our headcount levels over the next quarter, if not maybe slight increases in the back half of the year. So, no market changes but I think your points are well taken. The business demands that we keep people adequately trained and ready and so I don’t think you’ll see market decreases in that especially as we bring the furlough people back.

Thomas R. Wadewitz – J.P. Morgan

Then just two more quick ones and I’ll pass it on. The cost side impact from fuel, you mentioned an OR perspective but I think in the first quarter you said $20 million net headwind in fuel in terms of expenses greater than increase in surcharge revenue. Any thoughts on what that might have been in the second quarter? And, I also think weather cost impact, whether that was meaningful?

Oscar Munoz

The two questions, on fuel we did say around $20 in the first quarter. I’d say it’s slightly more than double in the second quarter, as you can obviously think through with the rapid increase so I say between $40 and $50 million in the quarter. On the Midwest flood I think it was a combination of things, the direct expenses including clean up were a couple of million here and there. But mostly, it did affect our network as Tony outlined and it impacted some of our volume on our interchange partners. So, it’s hard to gauge that but maybe a couple of cents in the quarter were regarding the floods.

Operator

Our next question comes from Edward M. Wolfe – Wolfe Research, LLC.

Edward M. Wolfe – Wolfe Research, LLC

Tony, you talked about the FRA, the personal injury stats for the first time in a while going against you. Can you talk specifically what some of those bad guys that happen in the quarter were? You know, what happened that took the momentum out and what are you doing to address those going forward?

Tony L. Ingram

Well, we were bumping up to an excellent quarter last year, that was one thing and we had a great second quarter last year. The injuries we had this year were non-serious injuries. We did have a couple of taxicab type accidents but not anything of concern. We’re still staying focused with our training plan going forward.

Edward M. Wolfe – Wolfe Research, LLC

So a lot of little things, nothing major is what you’re saying?

Tony L. Ingram

No major ones, correct.

Edward M. Wolfe – Wolfe Research, LLC

You also noted that the network velocity flattened because of both the flood impact and some export coal strain. Can you talk in terms of which of those created greater issues for the network and here in July if either or both of those feel better?

Tony L. Ingram

Well, there’s two things, a lot of times when you tie up trains on line of road because they can’t get through, your velocity is still running. And, we did have about two or three days of washouts in the Indian Kentucky area which slowed our trains down considerably and that affected us. And also, when you run more coal your coal trains run slower and when you butt that up against automotive trains that run much faster that you’ve reduced sometimes the mix of it brings the velocity down.

Edward M. Wolfe – Wolfe Research, LLC

So I’m guessing the mix hasn’t change but has the impact from the Midwest is that behind you at this point?

Tony L. Ingram

That’s correct but when you butt it up against last year your velocity can also be changed because your mix changed a little bit last year with the further reduction on the automotive side and the more increase in the coal train.

Edward M. Wolfe – Wolfe Research, LLC

Oscar, where are the legal fees? I’m guessing that’s in MS&O and can you give an amount? And, it sounds like based on appeals and other things there might be more going forward, is that fair to say?

Oscar Munoz

It is in MS&O and it’s not just litigation but the overall proxy contest and litigation costs are in there. I said the round two [inaudible] it’s close to $0.03 in the quarter.

Edward M. Wolfe – Wolfe Research, LLC

And going forward, what’s a good proxy to use?

Oscar Munoz

There will be some additional cost, a cent or so in the third quarter.

Edward M. Wolfe – Wolfe Research, LLC

At this point does the company plan to appeal the DuPont cases?

Michael J. Ward

We have appealed the DuPont cases Ed.

Edward M. Wolfe – Wolfe Research, LLC

And did you appeal them to the district court or back to the SCB?

Michael J. Ward

District court.

Edward M. Wolfe – Wolfe Research, LLC

Is there an ability to appeal the proxy vote or to do anything about that? Or, if the results are confirmed in X number of days like you expect, is that just kind of like what it is?

Michael J. Ward

Let me just step backwards on that. We expect the preliminary results sometime today or tomorrow. Both sides then get to examine those and see if there’s anything that they want to challenge which is a fairly normal process. So, we need to go through that process. As you know, we’re reconvening the meeting on July 25 to examine those results because we think those challenges will be through by then.

But then there’s the additional issue of Judge [Kaplan’s] findings where basically he recommended but said he didn’t have the authority to in effect sterilize the shares they acquired after the violated the federal securities laws. We have appealed that. The briefs are going in now, there’s oral hearings on the 25th of August and while the court moves at the pace it chooses, it does I think, understand the need to quickly resolve this. They actually set up an expedited hearing. We expect them to make an expedited decision. And until we get those preliminary results we really can’t tell whether sterilizing those votes would change the outcome of the election or not.

Edward M. Wolfe – Wolfe Research, LLC

So until you get that decision from the court you can’t seek those board members, is that the idea?

Michael J. Ward

Well, I think the final outcome of it is not clear until we get through those steps and I think we’ll know better once we get these preliminary results where it stands. But, the one thing that I think is worthwhile saying is that regardless of final outcome of the proxy vote, we look forward to working with our board of directors to continue to provide outstanding value to the shareholders as we have been doing over the last several years and as demonstrated by this second quarter results. So, regardless of the results here I think you’re going to see us continue on that path of strong shareholder value creation and we do realize the need to expeditiously as possible resolve and clarify these issues.

Edward M. Wolfe – Wolfe Research, LLC

Clarence, when I look at the domestic intermodal volume really going back to second quarter 07, we’ve seen this big step up. What would you say, is it the relationship with Burlington Northern, is it exports, is it a couple of big new customers? You had talked about Schneider at one point. What’s really driven that domestic intermodal volume up in this weak economy?

Clarence W. Gooden

It’s a combination of all of the above. It’s been our relationship with not only Schneider who has grown significantly but several other major trucking companies that as the fuel cost for those trucking companies have gone up the intermodal product has tended to be a more favorable product not unlike what you saw in JB Hunt’s earnings where their trucking side was down their intermodal side was up significantly. It has been our growth with the [B&SF], it has been our growth in our domestic product from the west coast, the transcontinental product that we’re providing there transloading out of international containers in to domestic containers on the west coast end. So, it’s not any one factor but it has been a multiple set of factors. We also started up a new train service from Charlotte in to Florida that is bringing product out of the Carolinas for export to the Caribbean and then bringing finished goods back out of the Caribbean back up in to the Carolinas. So, the combination of all of the above.

Edward M. Wolfe – Wolfe Research, LLC

And last question, Oscar when you take out fuel you’ve got expenses that are up 3% give or take and volumes that are down 3% give or take. Is that just the state of inflation that the world is seeing right now? Or, are there things that can improve?

Oscar Munoz

There are always things that can improve Ed. And again, that 3% is impacted on a year-over-year basis but a couple of those kind of adjustments we work through. Like with volumes being down where they are there’s lot of work to be done along with the flooding that we had in a couple of different places did create a little bit of an issue. But, we’re on it and we see it and we’ll work through it.

Edward M. Wolfe – Wolfe Research, LLC

Do you think we can get to a point where expenses net of fuel are flat by the end of the year?

Oscar Munoz

I’m not sure we’re going to provide that level of guidance. In fact generally, our productivity initiatives have always been to offset the general inflationary pressures and so I think that’s kind of where we stay with that.

Operator

Our next question comes from David Feinberg – Goldman Sachs

David Feinberg – Goldman Sachs

First question, I think you’ve discussed it in the past, I wanted to confirm the same store sales pricing growth that we’re seeing here in the second quarter, does that reflect price increases that were effected in 2007 or those in 2008? And as a follow up there, can you talk about how far we are through the repricing process for 08?

Clarence W. Gooden

If I understood you correctly, the question is if the same store sales are a quarter-to-quarter? Is that your question?

David Feinberg – Goldman Sachs

No, the 6.4% price increase we’re seeing, is that reflective of price increases that you issued to customers in 2007? In other words, did a lot of that come through in the back half of last year or is that actually reflective of price increases in 08? In other words, I’m trying to get a sense of the timing of when you’re effecting the bulk of your price increases.

Clarence W. Gooden

It’s some of both. It would be some carryover from 2007 and it would be some price increases that actually happen in 2008.

Michael J. Ward

It’s a year-over-year comparison.

Clarence W. Gooden

A year-over-year comparison, right.

David Feinberg – Goldman Sachs

I was a little confused in terms of the changes in international shipping patterns. We were kind of under the understanding that a lot of international shippers were moving directly to the east coast where we thought yourself and some of your competitors might be net beneficiaries. Can you talk about actually what changes are occurring? Is it just that there’s less ships coming to the US due to lower economic activity or are we missing a different change in shipping length?

Clarence W. Gooden

I would say there’s three factors there, the west coast inbound international business is down more than the east coast international business is down, so both of them are down, the east coast down less because of the business coming through the Panama Canal. But, because there’s more volume coming off the west coast than is coming off the east coast, that has been the principal and [inaudible] factor driving down our international traffic. The last point is that the international traffic that comes to the east coast, a lot of it doesn’t lend itself very easily to rail transportation because a large percentage of the US population is within 200 miles of the coast. So, those three factors affected it.

David Feinberg – Goldman Sachs

As a follow up there, is there a way that you can take advantage of more of the traffic coming to the east coast directly in the face of higher fuel prices? Or, is it really anything below 200 miles worth of distance you can’t effectively compete?

Clarence W. Gooden

I think there some places where we can effectively compete. For example, in that service side I described earlier that we started up from Charlotte to Florida, that certainly was within a 200 mile radius of the coast and its serving the ports of Savannah and Jacksonville and then connecting with FEC down in Fort Lauderdale and Miami.

David Feinberg – Goldman Sachs

Then one last question, export coal volumes doubled year-over-year and I think there was a comment earlier in the call about how that increase negatively impacted network operations throughout CSX’s network. What changes, if any, have you made and what do you still need to make in order to lessen that impact? Because, as you said, I don’t think you were looking for export coal volumes – you were looking for them to continue to grow at least for the next two years.

Clarence W. Gooden

Well, we have a huge coal field and when there are sources that come from different areas than those coal fields sometimes you have to go and add a siding or install some fire switches and those kinds of things and we’re on plan to do that. We’ve also added some additional locomotives to the areas for resources and added crew members which also gives us supply on man power. Other than that, we think we’re in pretty good shape. We believe some more coal cars. So, we’ve increased our capacity and improved our route to meet the demand that’s out there now.

Operator

Our next question comes from Gary Chase – Lehman Brothers.

Analyst for Gary Chase – Lehman Brothers

Oscar, I think you had mentioned the fuel surcharge lack impact from 1Q and 2Q. I was wondering if you could give us a feel of what it should be in the coming quarter?

Oscar Munoz

Well again, if we’re all [inaudible] to be able to forecast the future. We use the forward curve and I think if you look at that curve today I think you have a continuing headwind in to third quarter, although not as large as we saw in the second quarter. And, the fourth quarter I can’t even tell you because just like price changed rapidly the last few days, it’s hard to tell. We usually peg it to the forward curve in our internal outlooks but I would say a little bit of an impact in the third quarter. A little bit less than what we had in the second.

Analyst for Gary Chase – Lehman Brothers

Are we talking about amend it to the left than what we saw in the first quarter then?

Oscar Munoz

You know what, I’d love to tell you exactly but I don’t know. On the forward curve today, it would be greater than the first quarter but lesser than the second quarter. But again, that changes every day.

Analyst for Gary Chase – Lehman Brothers

Then I guess coming back to the guidance, staying at the high end of $3.40 to $3.60, just coming back to the pricing or the cost side it feels like you need to get some pricing X the fuel surcharge impact or maybe some more cost efficiencies. Can you just talk to us a little bit more about what you need to accomplish to hit that range?

Oscar Munoz

I think it’s a combination of all the levers. I think it’s organic volume growth, better service, greater productivity and pricing opportunities. So, it’s just that continued work that we’ve been doing.

Operator

Our next question comes from Matthew Troy – Citigroup.

Matthew Troy – Citigroup

Following up on some earlier questions, to the extent that the weak dollar is increasing exports I was wondering if you could add some commentary on its impact on your ability to load balance across the network of utilization? Are you guys hearing anything from shippers that indicates they’re anticipating any directional change in freight flows leaning towards greater exports? Again, outside of your commentary already on coal and intermodal? And, if so, what traffic other either by commodity type or region would you expect to see any impact or change in flows directionally?

Clarence W. Gooden

We’re seeing impact in flows of scrap metal for example that’s coming from deeper interior points that is moving to the coast for export. We’re seeing paper moves, particularly brown paper moves that are moving to the porch for export down in to the Caribbean and in to Central America that’s being made in to boxes that’s coming back in the forms of carrying fruits and vegetables from that region. We’re seeing some exports, large amounts of exports of distiller dried grain as a result of the ethanol being produced in this country and then DDG subsequently being shipped offshore. So, those are some examples of non-traditional export moves that we’ve been seeing.

Matthew Troy – Citigroup

Are the number of inquiries or the volume of the dialog with your customers about these potentials, is it growing? Is it more of the same? Just help me directionally, are we seeing a more significant move?

Clarence W. Gooden

It’s growing. I don’t know if I would describe it as a significant move but I would tell you that the amount of inquiries is growing.

Matthew Troy – Citigroup

Whether or not your accelerating, or decelerating or reevaluating any of your priorities in terms of capital budgeting and plan for 08 in light of the economic environment which is you know, sideways at best?

Oscar Munoz

I think first with the question in regards to an update on cap ex, I think the number that we’ve given for the year is $1.6 and I think the priorities we’ve established are straight forward. We’ve got a large portion going to the infrastructure, there’s some growth and some asset utilization as we do locomotives and then of course growth initiatives with technology and terminals. So, no change to the overall mix, no change to the number. And, as we develop our cap ex plan they’re done on a pretty go forward basis and we staff up to the right resources, Tony’s infrastructure crews are out there working, we bought materials ahead of time by in large with regards to that so it’s important for us to get our maintenance work done and we’ll continue to do that. With all the other initiatives we think they have high returns and despite the economic aspects of it, with our strong free cash flow we are staying put with the plan that we have.

Operator

Our next question comes from [Jason Sidel – Dahlman Rose]

[Jason Sidel – Dahlman Rose]

Clarence, you talked a little bit about the things you’ve done to add to the export coal volumes that you’ve been handling. How’s the capacity on the port side? How much more growth can you actually handle?

Clarence W. Gooden

Jason, if you’d asked me that question in the first quarter I would have had a lot of concern because the infrastructure in both Baltimore and Newport News in particular was really cranking up for the volumes that were coming. But, in the second quarter we’ve seen the ports to be very fluid. Tony’s team has kept cool if you will up against the fears on a daily basis and they’ve been able to handle the volumes that have been coming at them. They’ve handled them very well, they now have routine maintenance patterns in place so I feel comfortable that we’ll be able to handle the projected volumes.

[Jason Sidel – Dahlman Rose]

On the favorable traffic mix that you mentioned on the intermodal side, can you give us a little more color on that? Are you guys getting more revenue per unit on the domestic than you are on international?

Clarence W. Gooden

A lot of it has to do with the mix and the length of haul on the domestic side. The transcon business that we’ve seen the large increases in just carries our revenue per unit. On the international side, we have been able to get price increases on our contract and get fuel surcharge coverage and both of those together have had a positive impact on our RPU.

[Jason Sidel – Dahlman Rose]

Oscar, a quick one for you, when I’m looking at your share repurchases over the last two quarters it looks like it’s slowdown a little bit. In Q2 were you guys restricted more because of the ongoing proxy fight that you had or no?

Oscar Munoz

No, not really. I think we buy our shares on a [Pen B5] program or a structured program with the obvious parameters around that and we just bought to that. But, having said that, we are committed to the remaining $2.8 billion of the share repurchases being completed by the end of 09.

Operator

Our final question comes from William Greene – Morgan Stanley & Co.

William Greene – Morgan Stanley & Co.

I just wanted to add one quick follow up here, as you look at the challenges that the export coal surge talked about, it’s not clear to me if we had a rebound in the economy looking at say a year or so, how confident are you that you could handle that surge in growth and not have the productivity and on time performance get negatively affected?

Michael J. Ward

I think we’d love to have that challenge William. With our better discipline we run to the one plan here, some of our trains are not full right now. I think we could easily ramp up. Tony’s been calibrating the one plan as the volumes move. I think we have the ability to gear up and we would love to have that challenge.

Thank you for your participation today and hopefully we’ll see you next quarter.

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Source: CSX Corporation Q2 2008 Earnings Call Transcript
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