Kansas City Southern (KSU)

Q3 2011 Earnings Conference Call

October 21, 2011 8:45 AM ET

Executives

Michael Haverty – Chairman and CEO

Dave Starling – President and COO

David Ebbrecht – EVP, Operations

Pat Ottensmeyer – EVP, Sales & Marketing

Michael Upchurch – EVP and CFO

Analysts

William Greene – Morgan Stanley

Allison Landry – Credit Suisse

Scott Group – Wolfe Trahan

Thomas Wadewitz – JP Morgan

Christian Wetherbee – Citigroup

Kanchana Pinnapureddy – Stern Agee

Ken Hoexter – Banc of America

Jason Seidl – Dahlman Rose & Company

Anthony Gallo – Wells Fargo

Neal Deaton – BB&T Capital Market

Art Hatfield – Morgan Keegan

Presentation

Operator

Greetings, and welcome to the Kansas City Southern third quarter 2011 earnings call. (Operator instructions) As a reminder, this conference is being recorded.

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

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

Michael Haverty

Okay, thank you, and thank all of you for joining us this morning from Kansas City Southern’s third quarter earnings presentation, coming to you from Kansas City Southern headquarters. Today’s presenters are Dave Starling, the President and CEO; Dave Ebbrecht, Executive Vice President, Operations; Pat Ottensmeyer, Executive Vice President, Sales and Marketing; and Mike Upchurch, EVP and CFO. On the telephone from Mexico is Jose Bautista, President and Executive Representative, who will be available for the question and answer session.

If you’re following on the website, if you would turn to slide number five the third quarter results. I’m not going to go through those numbers. Those are unadjusted numbers and throughout this presentation you are going to hear about a lot of adjustments as a result of the hurricane related insurance coverage – recovery. So there is no real reason for me to go into detail on that.

Let me say this about the adjustments. I think that the management team did a very good job of showing in the adjustments just how well the company has performed, exclusive of the hurricane related insurance recoveries. And I think the way you are going to see is an apples to apples comparison done by the management team. Just to remind everyone, the hurricane we are talking about was Alex that hit in July 2010; main line in Kansas City Southern was out for 24 days from July 1 to the 24. and not only did management do a very good job of handling this disruption for that period of time, but also in the settlement that followed because they had very good data, very good documents we ended up collecting, a little over $63 million in cash from the insurance companies not only for direct losses, but also for loss of business.

While this quarter has a lot of numbers that are affected by the hurricane, I think there are two things that you need to look at that really indicate just how well our company is doing, and that is if you look at the carloads which set a record, and also the revenues which set a record. So that is indicative of just how well this company is doing. That has nothing to do with the adjustments and to think that in the past quarters we have never handled this many carloads nor had these high revenues. I think it is a real testament where this company is headed.

With that I am going to introduce Dave Starling, our President and CEO. Dave.

Dave Starling

Okay, thank you Mike and good morning to everyone. We will start on slide seven. This is the chart that we showed during our second quarter earnings presentation, which provides a brief overview of how KCS is progressing relative to the guidance we have previously provided.

The left-hand column restates the guidance we gave in January of low double-digit revenue growth, based on mid single digit volume and mid single pricing increases. Based on those projections, we anticipate 100 basis points to 150 basis points improvement in operating ratio in 2011. On the second quarter call, we slightly adjusted our guidance for the year, and stated that the second half of 2011 was shaping up to be somewhat better than the first half. This was all the more impressive given the first half came in a bit higher than our original guidance.

KCS third-quarter results illustrate that we continue to deliver on our guidance. Our third quarter adjusted revenues rose 16% over adjusted third quarter revenues in third quarter 2010. Just to remind you as Mike said we have adjusted 2011 volume revenue and operating ratio numbers by taking out the impact of hurricane Alex, which virtually shut our railroad down in July of 2010.

With the third quarter revenues in the book, our adjusted year-to-date revenue growth is 15%. Third quarter adjusted volume growth came in at 7%, somewhat higher than our mid single digit guidance, and in line with our six-month number. It should be noted as Mike said that third quarter volume and revenue numbers are records for KCS, and reflect the growth we are experiencing along our entire network. Third quarter same quarter pricing came in at 6.1%, and year-to-date same-store pricing is 5.7%.

All in all we are comfortable that our entire 2011 (inaudible) pricing guidance we provided earlier in the year. And finally our adjusted year-to-date operating ratio improved approximately 1 point year-over-year. To amplify a bit on our operating ratio, go to the next chart, which illustrates the continued positive trend in the relationship between carloads and margins. As you can see KCS posted operating ratio was 66.6%. If you adjust for the hurricane settlement the number is 71.3%.

Adjusted carloads for the quarter were 7% better than the prior third quarter, and up about 4% from the second quarter. We have altered the next chart a bit to make it more meaningful to you. During previous presentations, we have gone back to 2009, basically to show you how we have come out of the recession. Now in the spirit of what have you done for us lately, we thought it would be more reflective of our recent performance to go back just 12 months, rather than to the beginning of 2009.

The good news story is it remains very positive. The gap between our rolling average quarterly linehaul revenue and our rolling average quarterly operating cost continues to widen. The main story behind the chart is that KCS is doing a first rate job of controlling operating expenses, as its linehaul revenue continues to grow and that means more profit falling to the bottom line. All in all, we are very pleased with the progress we made in the third quarter. We did what we said we will do and somewhat exceeded our first half performance in some key areas.

We accomplished this despite two of our primary commodity groups being negatively affected by heavy flooding along the Missouri river. The floods forced the ten-week closure of the primary grain and coal rail corridors serving us in Kansas City. This affected cost, volumes, and train schedules. We are especially proud of our success in maintaining service levels for those customers, whose businesses were most affected by the flood conditions, and also our ability to minimize the impact of additional expenses cost by the necessary train diversions.

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