Some Shortline Railroad Finance Basics AAR Annual Meeting of the Railroad Treasury/Finance Division Naples, Florida 11/6/2007 Roy Blanchard, The Railroad Week in Review

“There is a need to work more closely with short lines in the light of growing regulatory and legislative pressures now facing the industry.” -- Mark Schmidt, BNSF, 3Q07 Short Line Newsletter

Short Lines and Class Is (FY 2006) Class ISL Rev UnitsClass I RUPct SL BNSF1,417,00010,637, % CN640,6004,824, % CP277,0002,618, % CSX926,9007,358, % KCS171,1001,921,0008.9% NS1,018,0007,901, % UP1,400,0009,852, %

The Shortline Railroad Universe: More than 500 shortline (regional and local) names, 43,000 route miles, 12 mm cars per year (cpy)* 32 S&Ts (BRC et al), steel roads (EJ&E) have 2600 route miles, 5.2 mm cpy NS has most (253), CP fewest (61) Top 20 SL ops companies (ex steel, S&T) roads, 27,000 miles, > 4 mm cpy Top 5 Commodities 2007 thru Q3: 16% forest products (lumber, panels, paper and related), 14% chemicals, 11% grain, 12% coal, 9% metals and related *More accurately, revenue units (I’ll explain)

Leading North American Short Line Operators OperatorRRSMiles of LineCars per YearCars/yr/mile RailAmerica ,140, Genesee & Wyoming ,021, Washington Group , DM&E22,300227,00099 OmniTrax172,600200,80077 Watco ,000e76 Anacostia & Pacific , Quebec Railway ,00051 Ohio Central751671,000e138 Rio Grande Pacific348457, Totals14523,4873,496,800149

How Short Lines Earn Their Money Revenue per carload, mostly from Class I divisions, allowances or fees; some ancillary fees (demurrage et al), property leases, short-haul intra-line moves. Class I pays short lines out of revenue per EITF99-19; can discourage short line participation if market manager performance is measured on total revenue. Common short line compensation schemes: ISS, handling fee, Jct Settlement, switch fees; the folly of car- hire reclaim. How fuel surcharge revenue is shared varies widely.

Shortline Economics Class I average FY 2006 revenue per merchandise load was US$1996. Shortline pro forma allowance still US$250-$300 per revenue load, does not go up with Class I RPU increases Double-digit Class I volume YTD 2007 decreases in low-rated commodities (forest products, aggregates, waste) hit allowance-based short lines the hardest Proposed regulatory and legislative limits to rate increases will hurt ISS short lines the most

Short Line 3Q07 YTD Commodity Trends CommodityClass I deltaSL deltaPP spread Grain-2.6%.09%2.51 Coal-0.8%-1.4%(0.63) Lumber, Wood-19.4%-17.3%2.06 Pulp, Paper-6.6%-8.7%(2.05) Chemicals4.5%7.7%3.25 Metals-9.2%-7.4%1.78

Class I vs. Short Line Expense Comparisons BNSFRailAmerica (1) ($millions)2005Pct of Rev2005Pct of Rev Revenues $ 12,987 $ 424 Expenses Comp & benefits $ 3, % $ % Purchased Services $ 1, % $ 337.8% Depreciation $ 1,0758.3% $ 317.3% Equipment Rents $ % $ % Fuel $ 1, % $ % Materials, other $ % $ % Total Ops Exp $ 10, % $ % Ops Income $ 2, % $ % Operating Ratio Note (1) FY 2005 was the last FY 10-K for RRA GWR not used because it reports consolidated results w Australia

Measuring Short Line Results Rules of thumb: Rule of 100, $5,000 per mile per year for track maintenance to meet FRA Class 2 specs, fuel burn 8-10 gallons per revenue unit per year Resources consumed per revenue unit (Watco): man-hours, car hire, fuel burn, switching hours, etc. EBITDA vs. Operating ratio: No tax advantage to capitalizing major expenditures, below-the-line items have little meaning for core values; puts focus on cash-generating capabilities of property. EBITDA margin 40% - 50% for well-run short line; CP estimates DM&E will be at 40% for CY 2007

Shortline Growth Most roads started as Class I branch lines Staggers Act encouraged spin-offs; effects of new STB ruling? Lines transferred at low cost on assumption that short line would continue to feed Class I core exclusively Some short lines “bought their freedom” (A&M/BNI) Recent short line transactions have been leases (BNI), Joint Ventures (NSC) Until recently SL pct volume growth > Class Is; Masking Class I losses? A bright spot: BNI short line units up 8% through 3q07

Short Line Realities Better than Class Is for gathering and distribution, small- customer service, local infrastructure funding Free up scarce Class I resources (locos esp) for core ops 60% of short lines may not meet minimum economic thresholds; exceptions are single-purpose lines w hi vols The most successful understand and complement Class I financial, commercial and operating goals

Shortline Consolidation Bethlehem Steel roads to Lehigh Valley Rail Mgt., Georgia Pacific to GWR, Alcoa to RailAmerica Consolidation among shortlines: RailNet to OmniTrax, Savage; Rail Management Group, Maryland Midland to GWR Second-tier moves – Caney Fork & Western to Cundiff Group Class Is wary of buyers over-paying

The Capacity Question AASHTO: Predicts 70% growth in freight volume by National Freight Infrastructure Capacity and Investment Study: Rails need to invest $135 bn in capacity over the next 30 years to meet demand. The AAR: HR 2116, S 1125: the Rail Freight Infrastructure Act of 2007, provides for 25% tax credit for new railroad capacity in both infrastructure and locomotives. See also Public-Private Partnerships

Short Line Capacity ASLRRA: Current federal tax credit program offsets up to 50% of the amount invested in new or rebuilt track. Railroad Rehabilitation and Improvement Financing (RRIF) Loans – Administered by FRA. Direct loans or loan guarantees for the acquisition, development, improvement or rehabilitation of existing or new intermodal or rail equipment facilities. State and local rail infrastructure funding varies by state, some more generous than others. Save Our Service (SOS) rail customer coalition lobbying for the tax credit extension

Closing thoughts: Possible Implications for Short Lines in a Re-regulated Railroad Environment Cost of Capital: Rate ceilings, low-rated commodities most, shortline concentration. Small Rate Cases: Risks of customer filing to remove commodity from exempt list. HR 2125: “Railroad competition and Improvement” Act does none of the above; nobody calls it “re-regulation.” Paper Barriers: Class Is holding off; “buying your freedom.” Competitive Access: A bad deal all around. A fable.

Thanks For your kind attention. Now for the fun part… It’s Q&A time!