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Edited Transcript of GWR earnings conference call or presentation 2-May-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Genesee & Wyoming Inc Earnings Call

GREENWICH May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Genesee & Wyoming Inc earnings conference call or presentation Tuesday, May 2, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Lewis Cunliffe

Genesee & Wyoming Inc. - U.K. MD of Freightliner Ltd

* David A. Brown

Genesee & Wyoming Inc. - COO

* John C. Hellmann

Genesee & Wyoming Inc. - CEO, President and Director

* Matthew O. Walsh

Genesee & Wyoming Inc. - EVP of Global Corporate Development

* Michael Miller

* Thomas D. Savage

Genesee & Wyoming Inc. - SVP of Corporate Development and Treasurer

* Timothy J. Gallagher

Genesee & Wyoming Inc. - CFO

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Conference Call Participants

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* Allison M. Landry

Crédit Suisse AG, Research Division - Director

* Amit Malhotra

Deutsche Bank AG, Research Division

* Bascome Majors

Susquehanna Financial Group, LLLP, Research Division - Research Analyst

* Christian F. Wetherbee

Citigroup Inc, Research Division - VP

* Ivan Yi

Wolfe Research, LLC - Research Analyst

* Justin Trennon Long

Stephens Inc., Research Division - Research Analyst

* Kenneth Scott Hoexter

BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials

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Presentation

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Operator [1]

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Ladies and gentlemen, we'd like to thank you for standing by, and welcome to the Q1 2017 earnings teleconference call. (Operator Instructions) And as a reminder, today's call will be recorded. I would now like to turn the conference over to our co-host and our facilitator as well as our Senior Vice President of Corporate Development and our Treasurer, Mr. Tom Savage. Please go ahead, sir.

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Thomas D. Savage, Genesee & Wyoming Inc. - SVP of Corporate Development and Treasurer [2]

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Good morning, and thank you for joining us today on Genesee & Wyoming's Q1 2017 Earnings Call. Please note that we will be referring to a slide presentation during today’s call. These slides are posted on the Investors page of our website, www.gwrr.com.

Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investors page of our website. We will start with the Safe Harbor statement and then proceed with the call.

Some of the statements we will make during this call, which represent our expectations or beliefs concerning future events, are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, which provides a safe harbor for such statements.

Our use of words such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including, but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission. Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. And you should recognize that this information is only accurate as of today’s date.

On the call today, we have 4 speakers: our President and CEO, Jack Hellmann; our Chief Financial Officer, TJ Gallagher; our Chief Operating Officer, David Brown; and our Chief Commercial Officer, Michael Miller.

I will now turn the call over to our President and CEO, Jack Hellmann.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [3]

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Thank you, Tom, and welcome to G&W's earnings call for the first quarter of 2017. As always, we'll start our call this morning with safety.

On Slide #3, you'll see that G&W completed the first quarter of 2017 with an industry-leading safety index of 0.7 injuries per 200,000 man-hours. We've made significant progress in enhancing the safety culture of Freightliner and look forward to another strong year in safety in 2017.

Now turning to Slide #4. Overall, I would say the first quarter of 2017 was not a perfect start to the year, but the trajectory of our business is positive. On this slide, you'll see that we have multiple items impacting our quarterly results. The first item was $3.2 million of corporate development expense, much of which related to our unsuccessful bid for Florida East Coast railways. FEC is a great railroad, serving an attractive market that we first bid on in 2007 and was recently sold again in a competitive process.

FEC's corporate headquarters is located a few miles from G&W's Jacksonville operation center, which would have enabled us to unlock considerable cost savings. Even with those synergies, however, our valuation was not competitive, and FEC's railroad operations, excluding its regional trucking business, effectively sold for around 14.5x trailing EBITDA based on publicly available information.

As a result, we maintained our acquisition discipline and shifted our focus to other investment opportunities that we think will generate greater returns for our shareholders.

The second item impacting the first quarter 2017 was $3.5 million of restructuring cost, primarily related to ERS in Continental Europe. Having reached agreement with the Dutch and German works councils, we have now closed 2 offices and expect to complete the business restructuring in the second quarter.

The third item that impacted the first quarter was a noncash mark-to-market of an intercompany loan to Australia and related cross-currency swap, which cost us $0.05 per share. As TJ will discuss in a moment, this expense will eventually unwind to a cumulative 0 impact over the 2-year life of the swap.

Now let's turn to the core business.

(technical difficulty)

was at the low end of our

(technical difficulty) with same railroad carload growth of 3%, while our adjusted operating ratio of 77.2% was 1.2 percentage points higher than expected. The majority of that extra expense in North America was in the casualties and expense line item and was due to higher-than-normal track washouts and derailments in the winter months. We see these results as unusual, with several small incidents across multiple geographies and not reflective of any trends, since our track has never been in better condition. In fact, our FRA reportable derailments have improved 44% over the past 3 years.

But the bottom line is that higher North American expense cost us around $0.04 per share in the first quarter.

In Australia, the first quarter results of the Glencore Rail acquisition were right on target. Our new partnership with Macquarie is operating smoothly, and our Australian business overall is on a nice growth trajectory. Not only did a manganese mine in the Northern Territory restart shipments in March, but we are also working on several other new business projects.

Turning to the U.K./Europe operations. Our first quarter results were $0.04 per share below our expectations for 2 reasons: first, a customer bankruptcy in Germany resulted in a $1.5 million receivables write-off; and our U.K. intermodal business had a higher operating expense on current intermodal routes. Stepping back from the details of the quarter for a moment, I'd make 3 big picture observations. First, in North America, our overall view of the economy is broadly unchanged in 2017. We continued to see modest carload growth, and we still see several new customer projects starting up later in the year. Although we are hopeful that we will see the U.S. economy turn the corner this year, we have not yet seen that in our shipments.

Second, in Australia, after nearly 3 years of navigating the collapse in global commodity prices and a resulting sharp decline in our shipments, our financial outlook has been getting progressively more positive.

Third, in the U.K./Europe, where we have consistently disappointed for 2 years now, we think the second half of 2017 will mark the inflection point for a business that endured 3 consecutive shocks over the past 2 years. The first shock was the collapse of the U.K. coal market, which led to our complete restructuring of the U.K. heavy haul business. The second shock was the deterioration of the ERS business in Continental Europe, where we are discontinuing unprofitable train services and restructuring to its modestly profitable core.

The third shock has been the unprecedented changes in the global container shipping industry, which has caused congestion across the U.K. ports and container supply chain as a result of mega ships unloading significantly more containers as well as from new U.K. port calling schedules that have been established by the new shipping alliances. As I will discuss on the next slides, we are well underway with operational and commercial responses to these market shifts, which are being implemented now and we expect to take hold in the second half of 2017.

Turning to Slide #5. We have summarized our progress in the ERS restructuring in Continental Europe. First, you can see the measures that we completed in the first quarter, and then you will see the final restructuring steps in the second quarter. In essence, we are in the process of completing our exit of the equipment leases associated with the business that we stopped operating, which run at approximately $1 million per quarter.

Once that is complete in the second half of 2017, we will be left with a smaller sustainable core business on the continent that is focused on the deep-sea intermodal sector.

Turning now to Slide #6. We'd like to provide a more detailed update on our U.K. intermodal business. As many of you know, the global container shipping industry has been going through unprecedented change and consolidation. Following a series of mergers and acquisitions, the global shipping lines have been reconfigured into major new alliances. For reference, we have shown a snapshot of the new alliances on Slide #7. The important point is that new routes and U.K. ports of call are being established, and we expect this to stabilize during the month of May, allowing us to adjust our operations to better align with the new container flows. This means that certain port calls are being rotated among the major U.K. ports that we serve, including Felixstowe, Southampton and London Gateway.

In addition, new mega ships continue to create port congestions, since higher numbers of containers are being unloaded from each ship, which has been making our rail service less efficient. For example, scheduled intermodal services more frequently depart with excess capacity and missed containers may either go by road or by an extra train service.

In response to these market changes, we've been implementing a series of commercial and operational measures that are also taking effect in May. Four of the changes include: one, new service plans to match new port calling patterns; two, lengthening trains and optimizing wagon configurations; three, conversion of spot traffic to guarantee contract volumes; and four, increased pricing on spot traffic moves. The bottom line is that we have an outstanding U.K. intermodal franchise that is adapting to meet major market shifts while continuing to provide world-class customer service.

Having said that, when a supply chain is reconfigured and is coupled with volume surges, our traffic flows are unlikely to be smooth right away. The acquisition of the Pentalver container logistics business, which has now been approved by the British competition authorities and then scheduled to close in early May, provides a partial release valve. Pentalver's complementary services of container storage in the ports as well as its trucking capability should allow us to capture a portion of any lost container volumes. As a result, we expect Pentalver to perform strongly for the remainder of 2017 and ahead of our acquisition plan.

Turning to Slide #8. Our priorities are unchanged for 2017. First, we are focused on maintaining our world-class safety performance. Second, we have an intense focus on the turnaround in the U.K./Europe segment and are making good progress. Third, we are working on significant new commercial development projects in each of our 3 geographic segments. Fourth, we are focused on acquisition integration, and I should note that our Northeast region made excellent progress in the first quarter with the Providence and Worcester integration. Fifth, we remain focused on U.S. public policy under the new administration, including tax reform, the Short Line Tax Credit and infrastructure policy.

With respect to the Short Line Tax Credit, we now have 38 co-sponsors in the Senate and 161 co-sponsors in the House. And finally, we are actively evaluating acquisition and investment opportunities across our global footprint.

And now I would like to turn the call over to our CFO, TJ Gallagher, who will review the details of the first quarter and our outlook for the remainder of 2017. TJ?

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Timothy J. Gallagher, Genesee & Wyoming Inc. - CFO [4]

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Thanks, Jack, and good morning, everyone. Turning to Slide 9 and results. Our adjusted diluted EPS were down $0.14. To put these results into context, I've listed a series of key items in each of our operating segments that impacted earnings when comparing Q1 2017 with Q1 2016.

In North America, net fuel prices were up $5 million -- were about $0.05 per share year-over-year, and fuel prices continue to be under the threshold at which G&W's core fuel surcharge program kicks in. Also, as Jack mentioned earlier, we had higher-than-normal washout and derailment expense in the quarter. For example, we had roughly $1 million in expense from the flooding in California earlier this year.

In Australia, Arrium filed bankruptcy in April of 2016, and therefore, Q1 2016 was the last quarter that included the Southern Iron fixed payment.

In our U.K./Europe segment, the largest year-over-year variance was U.K. intermodal, which Jack has already discussed, and we also had the $0.02 from the receivable write-off in Germany. Last, there is the noncash mark-to-market expense on the cross-currency swap we put in place to hedge the Australian dollar intercompany loan that partially funded the Glencore Rail acquisition. As a hedge on a floating rate intercompany loan, the swap doesn't qualify for hedge accounting, and therefore, noncash gains and losses flow through the P&L. Keep in mind that since the exchange rate on the swap and the intercompany loan and maturity is set, the noncash gains and losses over the life of the swap will net out to 0.

All these items mask the profit contribution from stronger same railroad revenues, which grew $22.5 million, or 4.8%, excluding currency.

Now let's move to our operating segments, starting with North America on Slide 10. First quarter revenues increased $19.7 million or 6.6%. Excluding the Providence and Worcester, same railroad revenues increased $12.3 million, or 4.1%, primarily due to stronger coal and agricultural products revenues.

Now moving to North American carloads on Slide 11. Same railroad traffic increased approximately 11,900 carloads or 3%. The significant variances were in coal, which is up over 14,000 carloads, or 30%, primarily due to higher steam coal shipments in our Midwest region.

The Lumber and Forest products was down 1,500 carloads, or 4%, primarily due to greater truck competition as well as lower log -- export log traffic to Asia. Our metallic ores traffic was down 1,300 carloads, or 21%, primarily due to a plant shutdown in July of last year.

Minerals and stone traffic increased approximately 2,400 carloads, or 5%, primarily due to higher rock salt and clay traffic, partially offset by lower aggregates traffic. The rock salt traffic is higher due to a more typical 2017 winter compared with the milder 2016 winter.

Petroleum Products traffic decreased roughly 1,400 carloads, or 5%, primarily due to lower NGL production and higher truck competition in our Northeast region.

Pulp and paper volumes decreased approximately 2,600 carloads, or 6%, primarily due to strong truck competition as well as a plant outage resulting from an explosion at a customer paper mill. And last, waste volumes increased approximately 2,200 carloads, or 26%, primarily due to a new customer contract.

Now moving to Slide 12. Same railroad North American average revenues per carload increased 1.2%. Excluding the impact of changes in the mix of commodities, changes in fuel surcharges as well as currency, average revenues per carload increased 2.9%. In this quarter, we had changes in customer mix within coal, metals, agricultural products and minerals and stone traffic that impacted average revenues per carload. Excluding these customer mix changes, the core pricing increase in the first quarter was around 3%.

Turning to Australian operations on Slide 13. Recall that our results include 100% of the revenue and operating income of our Australian business as we consolidate its results, but our net income attributable to G&W reflects only our 51% ownership interest.

In Q1, Australia revenues increased $22.1 million, or 42.7%, primarily due to Glencore Rail-related revenues. Also in the quarter, we had $4.6 million of revenues from 2 reopened mines that partially offset a $5.9 million decrease due to the loss of the Southern Iron fixed payment.

Now Slide 14. U.K./Europe revenues declined $5.3 million, or 4.1%, primarily due to the weaker British pound. Partially offsetting were revenue increases in U.K. intermodal, U.K. heavy haul and in Poland. U.K. intermodal revenues were up $3.9 million as container volumes continue to be strong post Brexit. Poland revenues increased $3.1 million, with higher construction aggregates in agricultural products traffic.

In our U.K. heavy haul business, revenues increased $1.4 million, primarily due to a new customer.

Now let's turn to Slide 15 and second quarter guidance. Let me refer you to our earlier safe harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ materially from our current expectations. These statements represent management's expectations regarding future results as of today, May 2, 2017, and we do not undertake any obligation to update this information. Also, please note that the guidance includes roughly 2 months of revenue and income from the Pentalver acquisition.

In the second quarter, we expect revenues of approximately $540 million and operating income between $100 million and $105 million. Net interest expense should be approximately $27 million, and we expect D&A of approximately $67 million.

Our effective tax rate should be around 38% and diluted shares should be 62.5 million. The bottom line is that we're expecting second quarter diluted EPS of approximately $0.70 to $0.75.

Same railroad North American volumes are expected to be roughly flat in Q2 compared with last year, as we expect stronger agricultural products and minerals and stone traffic to offset weaker petroleum products, metallic ores and pulp and paper traffic.

In Australia, the increase in same railroad carloads is primarily higher metallic ores traffic from the 2 reopened mines.

Last, U.K./Europe volumes are expected to decline between 2% and 6%. The decline reflects lower U.K. intermodal traffic due to the later 2017 Easter holiday and fewer working days in the quarter than in Q2 last year. Also contributing is the elimination of certain continental intermodal routes, with the restructure of ERS as well as lower U.K. coal volumes. These declines are expected to be partially offset by higher U.K. and Poland aggregates traffic.

Slide 16 provides a comparison of our original guidance from February to our updated Q2 guidance as well as an update on the second half of 2017. Our updated guidance for Q2 is about $0.07 lower at the midpoint than the $0.80 we provided in February. Relative to our original guidance, we expect a slight decrease in North America, a slight increase in Australia, and U.K./Europe to be approximately $0.06 lower, primarily due to lower infrastructure services planned by network rail in the U.K. and the U.K. intermodal transition that Jack discussed earlier.

For the second half of 2017, that is both Q3 and Q4, our outlook is unchanged with, again, North America slightly weaker and Australia slightly stronger.

In the U.K./Europe, our outlook is unchanged and reflects the final restructure of ERS, the implementation of the U.K. intermodal initiative that Jack described and the contribution from Pentalver.

Let me close with our balance sheet on Slide 17. We ended the quarter with net debt -- with net debt to total capitalization of 42%, net adjusted debt to adjusted EBITDA of 3.1x and $500 million of capacity under our revolver.

As a reminder, again, our Australia joint venture operations are now financed on a stand-alone basis nonrecourse to G&W, and the leverage metric we discuss is as calculated under the G&W parent credit facility, which funds and is secured by our North American and U.K./Europe operations.

And with that, I'll open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from the line of Chris Wetherbee of Citi.

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Christian F. Wetherbee, Citigroup Inc, Research Division - VP [2]

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I wanted to talk a little bit about the U.K. intermodal business. You guys highlighted some of the changes that are going on in that business. And just wanted to get a sense of maybe how we can think about the progress towards adjusting your network and then leveraging Pentalver to ultimately drive profitability here. It seems almost like a high-class problem, where you're going to have a lot of volume from some of these new megaships coming in, but it's going to be different than what we've seen before. So how does that kind of play out over the course of the next couple of quarters, and how is that captured in the guidance?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [3]

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Sure. Well, why don't we -- we actually have 2 speakers on the line from London as well. Matt Walsh, who all of you know, as well as Adam Cunliffe, who runs the intermodal business for us. And why don't I kick the call over to Matt, and he can give you a flavor for what's happening on the ground in the U.K. right now, and Adam can provide some chip shots as we go. So Matt, you want to talk about it a little bit?

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Matthew O. Walsh, Genesee & Wyoming Inc. - EVP of Global Corporate Development [4]

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Yes, sure. Thanks, Jack. And just to remind everyone sort of what we do over here. I mean, as Jack said, I mean, we sort of have this great service product of multiple trains every day running from each major port to inland terminal. And doing this successfully means that we need to run fully utilized trains in the most efficient way every day. So as we face those congestion issues, which we've been talking about here, which are compounded by sort of this new shift in demand patterns and -- as well as much bigger container ships, obviously, there is, as I think we called it, an unprecedented change in the market, which we are adapting to and working hard to continue to offer the product that we do. And what this really means is, we're working hard with the ports to reduce the congestion. So that means that on days of very, very high demand, we're making sure that they are loading the trains that they need to load and we don't have trains going out that aren't fully utilized, and it means that we're running longer trains wherever we can and working with the ports to make sure that, that's happening, and of course, keeping in mind that as these [align] to the ship ports, then obviously we have [the ships] along with that. And that's something that's finally coming to sort of stabilization or fruition starting in May as all those port calls have finally been announced. And it also means that we have to make sure that we have the right wagon size in the right place to match the shift in customer demand, which is something else that we're absolutely working through here. And then finally, as Jack said, working with our customers to make sure that we're converting -- in places where there is high demand and people need the service that we offer, we're converting people who have sort of been on more of a spot tariff basis to more a contracted basis. And places where people aren't willing to commit to that, then we're looking to increase our tariff rate. And the object of all of that is to really smooth that volatility that we've been experiencing to running sort of that optimized train and making sure we're getting paid to do that. And then when we look at Pentalver, Pentalver offers the sort of the longer term storage at the port, which really, as we see, is a nice counterbalance to some of that volatility, offering customers, who include both sort of the freight forwarders, the shipping companies, but also the end-users within all this congestion, a place to sort of -- and I think we call it sort of an escape valve, as a place to store their containers while their ultimate destination is decided upon. And that's both for the imports and for the exports. And being able to offer them both is actually quite important. And so it's actually a very nice complementary investment to what we have today. I don't know, Adam, would you add anything to that or...

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Adam Lewis Cunliffe, Genesee & Wyoming Inc. - U.K. MD of Freightliner Ltd [5]

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I don't think that there's much I can add to that, but what I can say from the first quarter is that the current daily range we have can spread between something where we have a $700 swing on a daily basis because of the kind of asset utilization problems we've got whereby the mega ships come in where we don't have enough capacity to serve them, but the customer base is looking for the capacity at a higher level. So for the very reasons jack and Matt have now outlined, having a service plan that allows us to offer something where there are longer trains and services where there's high demand and converting spot contract, which is something we are having a huge (inaudible) at the moment to actually address those inconsistencies. Delivery is something we're working on very hard.

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Christian F. Wetherbee, Citigroup Inc, Research Division - VP [6]

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And just following up on -- that's really helpful and following up on the question about the guidance, it looks like you have, I think, one more quarter of headwind in there before this starts to normalize in term -- and I guess, that's sort of driven by the fact that we have a scheduling changing in May and then sort of you're adjusting your operations. Is that the way we should think about that?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [7]

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Yes, you're -- what you're seeing is a mixture of operational changes as well as rate changes starting to [bite start] -- in May. You flow into the third quarter. A good chunk of them will be fully implemented as the volumes are increasing because from a seasonal standpoint, Q3, Q4 is when we pick up. And so you're starting to feel the normalized business in the back half of the year. I think -- I mean, you asked a question about guidance. We probably -- we left some cushion in there on things not going perfectly by not adjusting our outlook for Pentalver, because we think Pentalver is going to do better. And so we -- this is our best estimate of the outlook as of today, which gives us some cushion on the Pentalver side. Because if things aren't flowing smoothly, our parking lot's going to be full.

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Christian F. Wetherbee, Citigroup Inc, Research Division - VP [8]

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Okay. That's helpful. And then just one follow-up on sort of acquisition. You spent some time on the FECR at the beginning of the call. Just wanted to get a sense, post that transaction, how do you see the landscape, particularly for deals of a degree of size like FECR was? I mean, are there other sort of interesting opportunities out there of size? Or maybe we're thinking about sort of smaller opportunities as you go forward? Just trying to get a sense of how the landscape looks now.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [9]

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Yes. I mean, there's both. We have an active pipeline of both acquisitions and investments across the global footprint that we think could generate good returns, and some are bigger than others, and that was, obviously, a big one. And so when I said on our last call -- I think the question was, are you skewed towards any one geography? I said North America, but I also caveated that I will be wrong in terms of whatever I say, and I guess, I was right in that regard. But that skewing towards North America was derivative of our attention to FEC. But we still have stuff -- we have an active pipeline that's going on in multiple geographies right now.

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Operator [10]

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Our next question will come from the line of Ken Hoexter of Merrill Lynch.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [11]

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Look at the 3 major acquisitions at the same time. Given how quickly, I guess, coal and some of the U.K. business melted down, how do you step back and look at that? Do you want to kind of step back and maybe focus on a region? Did business really just change that quickly? And I guess, if you bring it back to the U.S., do you see underlying growth at the core assets? I think, Jack, you mentioned at the start you're not really seeing it in North America, a bit of a contrast to some of the large rails. Maybe dig into that a little bit as well.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [12]

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Sure. Ken, I think the first part of your question, you might have been on mute for. I think it -- I think you started talking, we didn't pick up the first part of it. But I think it related to the perspective on the U.K. acquisition.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [13]

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I think just doing 3 major -- sorry, it wasn't from my side, but maybe doing the 3 major global ones at the same time, how quickly coal and other business melted down in the U.K., do you kind of step back and say maybe we need to slow down that, doing multiple at the same time and kind of focus and integrate? Or do you feel like it was just something that, hey, the business really changed that quickly?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [14]

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No, I mean, definitely not. Each acquisition is reviewed in gruesome detail and isolation, and we'd never be biting off things we didn't think we could handle. So it's the latter. The business changed quickly, but I'm pretty philosophical about it, because it's been painful for 2 years. You've had shock after shock in the U.K. Two out of the 3 shocks, we had anticipated in some shape or form in that the coal we expected to go away. It just went away a lot more quickly. So we hadn't ascribed that much value to the coal as part of the long-term franchise, but we've had to navigate restructuring sooner than we expected as well as the overhang of some leases. But that was expected. With respect to the ERS in Continental Europe, we ascribed a little bit of value to it in the acquisition model thinking that there could be some upside option value of that franchise. As we got into it, we decided that, that was incorrect. Cut your losses and move on and focus on the part of the business which is solid, which is what we're doing now. And so really, the only one of the bunch that sort of in terms of if you look out at, say, year 3 or 4 of a long-term cash flow contribution of the business, the only surprise one has been the -- or the true surprise -- I mean, each of those events is obviously painful in its own right. But it's been the intermodal -- the changes in the intermodal markets that we're working through right now. And the -- I mean, and the issue isn't one of volume. The issue is one of new operating plans based on new container flows in conjunction with a restructuring of an industry which is -- which truly is unprecedented if you look at the container shipping industry. But the fact of the matter is we're well positioned to, as that market stabilizes, to capture a significant share based on an outstanding service product. And with Pentalver, we think that only enhances the franchise. So I think you'll look back on Freightliner, and I do expect it to be on or ahead of what we expected when we originally purchased it. But obviously, our timing was terrible. But we're getting it there, and there's a lot of people working on chipping away at it. Now with respect to North America, the -- I'd say there's modest growth. It's truly a commodity-by-commodity, customer-by-customer outlook. There's some modest growth in the business right now. It's flat to slightly increasing. We've got some plants that are coming online later in the year, whether it's rebar in Oklahoma or cement in Dallas or DDGs and cement in South Dakota or whatever -- there's a bunch of other stuff coming online. You can see these projects coming through the industrial development pipeline and kicking in, in the back half of the year. Coal's been a little better than we expected thus far in the year. And that's going to be -- it's now the peaking facility. So the heat of the summer is going to dictate how that plays out over the course of the year. I think we've been pretty cautious in our outlook for coal, but maybe it'll heat up in the Midwest, and we'll do a little better. Let's see, what other things? I mean, paper, we've been off a little bit in paper. But for us in the paper commodity group, half the shortfall is an explosion at the plant, which was out of service, I don't know, Michael, for what, 2, 3 months, something like that?

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Michael Miller, [15]

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2 months.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [16]

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Yes, 2 months. We did have a chemicals plant close, which is sort of a one-off thing, up in our Northeast region, which is affecting carloads as well. But overall, the economy feels okay, but we haven't seen any signs of sort of accelerating around the corner or anything like that. There's lots of interesting dynamics afoot. There's lumber tariffs being contemplated between the U.S. and Canada. Calculating its impact on us is pretty tricky. I would -- for lack of a better answer, I'd say it's probably pretty neutral for us, because we'll get a positive lift on the West Coast of the United States from competing British Columbian lumber. But where we're the receiving end of lumber, for example, in New England, that may curtail shipments dropping down from Canada. And then I -- but I can caveat that by saying that lumber has to come from somewhere, and we may end up originating it in the southeastern United States. So there's a lot of patterns that remain to get -- to play out in lumber. Any other commodities to talk about? I think that's a good flavor for it, but the economy feels okay. It feels okay.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [17]

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That's a good rundown. Just one other follow-up, I guess, on Australia. Do you have other mines coming back? I guess, do you get a heads up as they're coming back to stage assets and prepare? You talked about the mines coming out. I just wanted to understand maybe the magnitude of what we could see as business returns.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [18]

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Yes. Well, it's -- some of it's new mines coming up and some of it is -- we're bidding on new -- on projects in various geographies right now. And so there's a lot of stuff in the hopper. I'll tell you, I've never gone through a commodity cycle like this one. So I'm not speaking with multiple decades of experience here. I have been surprised at how quickly some of these mines have come back on. You watch that -- I mean, it's fairly obvious, with the benefit of hindsight, you'll watch a commodity price jump up 45% and puts the mine back in the money. People suddenly start hustling and figuring out how to make it work, even if it got to in care and maintenance. And so I've been surprised at how quickly a couple of these mines have come back on. But the ones that we're looking at now, I would say, are less about new mines coming back on and more about new projects that we're bidding on at existing mines that are actually operational today. So it's a slightly different dynamic than what you've seen so far. Yes, Dave Brown's on the line from Australia. I don't know if you -- Dave, would you add anything to that?

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David A. Brown, Genesee & Wyoming Inc. - COO [19]

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No, I think you've covered it well, Jack. I mean, the particular manganese mine that you mentioned in your slide deck was really, within a 30-day window, was mobilized with the assets we had available to restart that. So we have -- we do have some excess capacity in our resources in Australia, and the Australia team was very focused on being nimble, as new opportunities present themselves, to get them online quickly.

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Operator [20]

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Our next question will come from the line of Allison Landry of Crédit Suisse.

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Allison M. Landry, Crédit Suisse AG, Research Division - Director [21]

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With the management change at CSX and the rapid network rationalization that's in motion, have you had discussions with the company? Or do you see any opportunities to short line any of CSX' business? And if opportunities do exist, do you think you have a competitive advantage, given the success you had with improving the operations of the West DM&E following the deal that you made with CP when Hunter was at the helm?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [22]

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Well, I mean, the short answer is -- I mean, the Rapid City, Pierre & Eastern is a wonderful precedent in terms of the value of the short line model, because that was a transaction where the -- it was a great deal for the CP. It turned out to be a terrific deal for us. It's been good for the customers, and it's been good for the state. And so that was one of the larger short line deals that had happened in a long, long time. And by all accounts, that's been a very, very successful transaction for all parties concerned. So it's certainly good to have a precedent like that. In terms of how one answers the other question, it's really a question for CSX themselves. I mean, when you think -- I mean, the way I think about it is, they've -- their market capitalization's increased about, I don't know, $15 billion over a very short interval of time. And the idea that you're going to unlock $15 billion of value from doing short lines is probably unlikely. There's a lot of other things that are going to happen first with respect to the precision railroading and all the things that will make the network more fluid and generate more profits and free cash flow. And then I think a natural -- as time progresses and they look at how the network is performing and where there's lower density lines, then I think a logical secondary step might be in the world of short lines. But I'm guessing it's not -- certainly not #1 out of the chute, and ultimately, it's a question for the team at CSX.

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Allison M. Landry, Crédit Suisse AG, Research Division - Director [23]

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Okay. That was a helpful explanation. And then my second question relates to the petrochemical opportunity in the Southeast that basically should be coming online over the next few years and we're starting to hear the Class Is talk a little bit more about it. And it seems like from the producer angle, that what we're hearing is that they're looking -- obviously, much of this is going to be exported, but they sort of want to utilize any port that they can to get the product to market. So I was wondering how you think about your opportunity to be involved in that.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [24]

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Michael, do you want to answer that? Did you hear the question in its entirety, Michael?

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Michael Miller, [25]

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I did. I did. And Allison, I think our view of this is we're working very closely with the plastics producers. And clearly, the key driver here is going to be empty boxes and ports that have balance. We're looking at all the ports that we serve. We're working with the ports that we serve, and we're actually working with producers to come up with the supply chain solution that helps. I don't think anybody's put flags in the ground yet. Clearly, there's some solutions been developed around Dallas for export boxes there going back to the West Coast. There's certainly -- each of the East Coast ports are looking at solutions, and the Gulf Coast ports are going to be the closest to proximity. All I can say is this. We are out there working with the customers and the ports. And if an opportunity presents itself, we'll be in a good position to develop the solution. We know what levers that producers are looking for, and we're trying to make sure we have those available to them if they pick a port that we serve.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [26]

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Michael, you want to talk a little bit about some of the plastics that we currently serve today or is coming online, whether it's in Corpus or in the P&W storage? Or just give some color on the plastics.

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Michael Miller, [27]

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Yes. I mean, Allison, we do serve several plastics facilities in the Southwestern market in the Gulf Coast. So we are close with those customers. There is a new facility coming online at Corpus where we serve. Some of that will be export. Some of that will displace some domestic production. I mean, we see it as a large growth opportunity. How much we play in it will ultimately be as to where the products ultimately flow for export.

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Allison M. Landry, Crédit Suisse AG, Research Division - Director [28]

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Right. Okay. But overall, the takeaway is that it is -- you do see it as a pretty significant volume and revenue opportunity.

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Michael Miller, [29]

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I think, clearly, for the industry, it could be a positive. The ultimate question is going to be where does it flow to get put into the containers, because the vast majority of what's being -- coming online is for export.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [30]

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It's certainly a staggering size of opportunity in that industry, and so we -- it's -- as a business development target, it's certainly way up there on the priority list because of the magnitude of the -- you know what the magnitude of the investment is not just this year, but the coming year is that which is planned right now. And we're trying to figure out how to best position ourselves.

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Operator [31]

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Our next question will come from the line of Scott Group with Wolfe Research.

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Ivan Yi, Wolfe Research, LLC - Research Analyst [32]

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This is Ivan Yi on for Scott Group. First on M&A. Given the 14.5 EBITDA multiple paid for Florida East Coast, is the M&A market simply becoming more competitive? Also, does the valuation on this deal in any way change how you value your own asset in the market?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [33]

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Does it -- so the first part of the question was does it impact how we think about valuation? I'm sorry, repeat -- competition? Yes, I mean, the competition, the -- for stand-alone competitive auctions, there's typically -- we won't always be successful. What was unusual about this one was that we had tremendous synergies. And from a "holding all other variables constant" standpoint, we should be a successful acquirer because of the magnitude of those synergies. So yes, that evaluation on a stand-alone basis was surprising. Having said that, we've been doing this for a long time and have seen cycles like this, and our footprint is much wider now than it ever was historically. And so we see, across our global footprint, opportunities where we think we're uniquely positioned to be making investments that yield our typical return profile and in ways that wouldn't be open to a broader competitive auction process. It's -- whether we're providing operating acumen or whether you're in a geography where other people just aren't, there's ample places to deploy capital where you don't have to -- we're never going to compromise our investment criteria. Let's see. What was the rest of the question? Did I cover most of it?

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Ivan Yi, Wolfe Research, LLC - Research Analyst [34]

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Yes. I just wanted to specifically hone in on how does this deal impact the way you value your own assets.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [35]

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It's not in terms of how we value the assets. It would be how the market values our assets. I mean, it's obviously -- it's pretty high valuation. And so yes, in relative terms, that's quite an arbitrage.

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Ivan Yi, Wolfe Research, LLC - Research Analyst [36]

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Great. Secondly, on the regulatory side, can we still get the Short Line Tax Credit if we get broader tax reform? Meaning, would any task reform eliminate the tax credits?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [37]

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Not necessarily. I mean, I think in a perfect world, the broader tax reform would be tremendously beneficial to us, and we would -- so we're eager to see some variation of some plan be implemented, because for an asset-intensive business, most variations of those plans are highly favorable to companies that invest as we do domestically. And then whether the Short Line Tax Credit -- it falls in the infrastructure bucket, and so it may not -- its guise may no longer be a tax credit, it could be some other infrastructure-related plan. There are several scenarios where you have your cake and eat it too, where you're a beneficiary of the broader corporate tax plan and -- tax reform and find some version of the Short Line Tax Credit, which is a public-private partnership, which is in line with the current administration's thinking or some variant thereof that becomes a stimulus for infrastructure spending and lets us continue to do what we've always done in upgrading our railroads. So I don't think they're mutually exclusive. From a policy standpoint, we'll certainly be -- I can assure you we're looking at both. Most importantly is just to get something to happen.

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Operator [38]

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Our next question will come from the line of Bascome Majors of Susquehanna.

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Bascome Majors, Susquehanna Financial Group, LLLP, Research Division - Research Analyst [39]

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Just following up on the earlier question about how the Class I outlook's maybe on the balance for North America sounded a little more constructive than what you've laid out. Is -- I mean, I realize your commodity mix isn't terribly truck-competitive, with very little intermodal in it in the region, but your length of haul is also considerably shorter than your Class I partners. Is truck competition playing into this in any way? I mean, have you felt that in ways that you haven't in previous years? Can you just kind of give us an update on where you sit versus truck and if that balance is changing at all?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [40]

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Yes. I mean, I'll kick it to Michael in a second here. The place we've been feeling truck recently has been -- and we have been for some time, has been paper, and it's been derivative of low fuel prices. And in certain geographies, we've felt it. You've seen it flowing through our numbers for some time. And so we are working extremely hard with our major paper customers to alter their perspective on the economics of rail. And I wouldn't say -- I mean, I don't think of it in terms of length of haul per se relative to the Class I. We're part of the continuous haul overall. And so it's a question of getting goods through routes, efficient routes and -- at appropriate rates to stimulate some more modal shift back to rail, because we think we can be doing better in paper than we have been doing and are focused on it. So I don't know, Michael, you want to talk a little bit about paper, or anywhere else you want to talk about truck competition?

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Michael Miller, [41]

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Yes, Bascome, I would say -- I mean, we do face truck competition in paper, in lumber, also in metals. And I would say just because we don't have an intermodal portfolio doesn't mean we don't face truck competition. And clearly, that has been a little bit of a headwind for us. I mean, to put it in perspective, base truck rates in general haven't changed in 10 years. It's all been fuel related. So with low fuel prices, it does create a significant competitor out there, and we are working really closely with our customers to really understand what's being converted, what can we convert back. And actually, probably the single biggest growth opportunity for us in North America is going to be modal shift back to the industrial products carload business. So we are really focused on it. Clearly, we think there's going to be opportunities as truck capacity gets a little tighter or fuel prices go up. We just have to stay very close, work very closely with our customers and know what opportunities are there to convert from highway to rail.

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Bascome Majors, Susquehanna Financial Group, LLLP, Research Division - Research Analyst [42]

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Well, I appreciate the comprehensive answer there. From a high level, can you give us a perspective on where free cash flow outlook sits for the year relative to what you laid out in February?

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Timothy J. Gallagher, Genesee & Wyoming Inc. - CFO [43]

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Sure, Bascome. This is TJ. I believe our original free cash flow forecast was around $278 million. With all the puts and takes we've talked about, my best guess right now is we may be a little lower, $270 million. So it's still in the same zip code, not materially different.

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Operator [44]

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Our next question will come from the line of Justin Long of Stephens.

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [45]

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So I wanted to ask first about the longer term picture for the European segment, given all the changes over the past couple of years that you walked through. I guess, first, once the planned restructuring is complete, what do you view as the annual run rate operating income for that business? And then second, how should we think about the long-term growth profile of this business off of that new base?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [46]

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Matt, do you want to sketch out just a broad picture in pounds? And we haven't really given that information, so we'll speak to it very broadly. But do you want to just give a schematic on that? Just speak to it in EBITDA instead of EBIT.

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Matthew O. Walsh, Genesee & Wyoming Inc. - EVP of Global Corporate Development [47]

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Sure. I mean, I want to be -- I probably looked at, Jack, what we discussed what we have in our guidance here and maybe thinking about that on a -- for the second half of the year and thinking about it as a run rate business. When we talk about the U.K. and some of the projects that are undergoing here, there are some pretty significant infrastructure projects that we're quite optimistic about. One is HS2, which is a significant -- it's probably one of the largest infrastructure projects in the world, where it's constructing new high-speed rail line moving north from London up towards Birmingham and then points north from there, the expansion of the third runway at Heathrow. There's also some large power -- energy facilities being constructed, which all point to sort of increased demand for aggregate, which we would expect to play a significant part in. So I think on a -- from the bulk side, which you've heard us talk less about, we're actually quite optimistic about the growth of that over the next couple of years. I mean, it is difficult to put specific numbers around that, but those are all quite positive. On the intermodal side, I think we are -- we should grow, and I think the way we think about the business is that it grows sort of along with port growth and maritime container growth, which typically has been GDP plus. And I would -- that's how we think about that business. So I would start with, and I'm trying to be as helpful as possible here, thinking about our run rate for the second quarter here -- sorry, for the second half of the year in terms of our guidance. And thinking about that on a run-rate basis and then with some good growth opportunity from that. And then I think the addition of Pentalver is a big benefit in terms of increasing our footprint and really falls into our -- how we communicate our acquisition plan to the market, which is when we make an investment in an existing footprint and then grow through complementary acquisitions from there, which I think is another good example of that and then should lead to opportunity for further investment. So I'm -- I think, Jack, and I'm probably most comfortable in answering it in that way if that's okay.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [48]

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No, that's good. That's perfect.

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Matthew O. Walsh, Genesee & Wyoming Inc. - EVP of Global Corporate Development [49]

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I'm just looking here, on an EBITDA basis for the second half of the year, I think what we're guiding people to in the U.K. and Europe is anywhere between $40 million to $45 million of EBITDA on a run-rate basis. So I think that's probably how we see the business and then -- with sort of that upside coming from there. So...

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [50]

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Okay. Great, Matt. That's really helpful. And then maybe secondly, on the second half guidance, I was wondering what you're assuming for the change in same railroad volumes within North America. And maybe within that number, if you could talk about your outlook for coal and grains, and so they're 2 areas where the comps get quite a bit tougher in the back half.

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Timothy J. Gallagher, Genesee & Wyoming Inc. - CFO [51]

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So overall, for the -- our updated outlook for the full year in North America, the carloads are modestly positive. So with respect to coal, I mean, that's the wildcard. Right now, it's basically flat for the full year, stronger first quarter. In our guidance, it's flat for the full year. But again, depending on the summer and the weather, we'll see how it goes. Agricultural products, we've got tougher comps. But again, right now, our outlook is up.

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Operator [52]

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Due to time constraints, our last question will come from the line of Amit Malhotra of Deutsche Bank.

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Amit Malhotra, Deutsche Bank AG, Research Division [53]

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First one is just a quick one. It's related to the cyclone in Australia or, I guess, the typhoon in Australia. Just wondering if that has had an impact on the second quarter. Just trying to understand what the disruption is there. So maybe that's maybe depressing second quarter.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [54]

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No, it's -- Dave, do you want to talk about the typhoon that (inaudible) left before it got to us? I assume that's the one you're talking about.

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Amit Malhotra, Deutsche Bank AG, Research Division [55]

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Yes.

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David A. Brown, Genesee & Wyoming Inc. - COO [56]

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Yes, cyclone Debbie. That actually affected Queensland coal production and transport. But once it really came inland sort of 500, 600 kilometers north of Brisbane, it came inland and took a little bit of a left and then just dissipated. So our biggest concern was downstream impacts in the interior, which didn't materialize. So it did not affect our coal business at all.

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Amit Malhotra, Deutsche Bank AG, Research Division [57]

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Okay. That's great. Let me just ask one more kind of related to an earlier question about free cash flow. Just more sort of philosophical question. I'd imagine that given the acquisitive nature of the company, that's kind of the number that I would imagine that the management team would be focused on. So just beyond this year, I mean, just high level, I'm not asking for guidance, but I'm just trying to understand, given the outlook for the earnings profile, the pipeline of new deals, what type of free cash flow per share growth over sort of the midterm are you -- would you want to target and look back and say, "Okay, this is what we achieved, and it was successful.” And then kind of related to that, you guys have this value-added parameter in your long-term incentive framework. It just seems like it's a proxy for return on invested capital, if I read it correctly, which is, obviously, great. But it seems like it could also introduce the potential for maybe some underinvestment in the business or potential for underinvestment in the business. And maybe I'm reading that wrong, but if you could just talk about that and help us understand.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [58]

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Sure. The -- yes, I think your second question is a great one in terms of how one structures any kind of compensation framework, because especially in an asset-intensive industry, when you slap EVA-type programs on their management, there -- ultimately, you've got to have complete trust in the quality of the people running the business, that they're not starving the assets like you'll -- and they're being invested in appropriately. The best way to judge that, by the way, is what the trajectory is and the trend line is and things like FRA reportable derailments and the like, which, in our case, have come down the last 3 years 45%, and our assets have never been in better shape. So that's ultimately a judgment call as to how good the management you have in place running each of those operations and whether they're appropriately investing for the long term, and we are -- and the reason it works within our framework is we sort of have a trust but verify -- the old Ronald Reagan trust but verify operation of the business, whereby in addition to each of the regions having tremendous autonomy in terms of how they run their businesses and invest their businesses, we have a check of best practices and various metrics that we apply across the capital plans for each of our regions to ensure that we're investing at appropriate levels. And so that's a rigorous part of our budgeting process, and it basically puts a -- not just -- in addition to trusting your -- that you've got great people running your business, it puts another crosscheck on it, making sure you're investing at levels that are -- that make good sense in the context of the 10 other regions that you operate, because we can benchmark versus ourselves very easily in terms of how we're doing internally for each of our 10 operating regions. It's a terrific question, because it's the biggest -- that's the one you always got to keep your eye on, and we've got -- we've institutionalized processes, whether they be safety or these budgeting checks to make sure that we're always investing appropriately.

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Amit Malhotra, Deutsche Bank AG, Research Division [59]

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Could you address the free cash flow one?

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [60]

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Sure. Was that answer not good enough? I thought it felt pretty good.

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Amit Malhotra, Deutsche Bank AG, Research Division [61]

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That was a great answer, but I had a couple of part question, unfortunately.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [62]

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Yes. No, I mean, my answer on free cash -- you can see over the last couple of years, if you look at our book earnings, I'm going to talk in rough numbers off the top of my head. But you've been looking at -- book earnings declines of, right, what, 10% to 15%, but we've been growing our free cash flow at about 10% per year in a tough environment, free cash flow per share if you do the math on that. And that's in a pretty down market. And so my target -- if we're doing our job deploying capital well, investing appropriately, we should be growing at that long term 15% to 20% free cash flow per share rate as our target. I mean, that's what our internal profile is for growth for the company. It's often expressed as a book EPS number. To your point, you're right, it's a free cash flow number that's relevant, and that is in terms of how we measure the management of the business. And you can see, we've managed through some pretty rough years over the last 2, 3 years, and you've watched our free cash flow not only remain stable, but actually sequentially increasing through a tough part of the cycle. So I think the short answer to my question is that you think, I mean, structurally, holding tax policy constant, holding every other variable constant, can we grow at that rate inclusive of the incremental free cash flow of acquisitions? Yes, that's kind of where we are.

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Operator [63]

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There are no further questions in queue at this time.

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John C. Hellmann, Genesee & Wyoming Inc. - CEO, President and Director [64]

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Great. Well, thank you all for joining us on our first quarter call, and we look forward to speaking with you again soon. Take care.

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Operator [65]

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Ladies and gentlemen, that does conclude our conference call for today. On behalf of today's panel, we'd like to thank you for your participation in today's Q1 2017 earnings call, and thank you for using AT&T. Have a wonderful day. You may now disconnect.