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Operator
Good morning, and welcome to the Norfolk Southern Corporation first quarter earnings conference call.
All participants have been placed on a listen-only mode for the duration of the call.
At this time, I will place you into the main conference.
You may hear background noise until a conference begins.
David Goode - Chairman, President and CEO
Okay, Debbie, if you will -- good morning.
I'm David Goode and on behalf of Norfolk Southern I'm happy to welcome you to our first quarter 2003 analyst meeting and I welcome those who are listening by telephone conference call and as I'm always asked to do I'll urge those who are here and later on in the question period to stay close to a microphone or get a microphone so that our telephone participants can hear you and I will remind our listeners and internet participants that the text and slides are available for your convenience on our web site in the investigating in the Thoroughbred section.
As usual, transcripts will be available from our PR department in a couple of weeks and they'll also be posted on our web site.
Let me take a minute to quickly introduce the representatives of our management team who are here with us.
Present today we have our vice chairman, Ike Prillaman, also our Chief Marketing Officer, Stephen Tobias, our Chief Operating Officer and Hank Wolf, Chief Financial Officer.
Also with us in the front row John Rathbone, our senior vice president and controller, Bob Fort, I am not going to call you my head flack but I sometimes do, information minister Bob Fort.
On a more serious note, Bill Galanko, our vice president taxation is with us here, along with Leanne McGruder who I hope you all know, our director of Investor Relations.
And as always importantly Debbie Malvin, Hank Wolf's assistant is in the back of the room.
Now, let me start by saying that on the whole I'm pleased with our first quarter results.
They reflect the highest railway operating of revenues in of any first quarter in Norfolk Southern history and they are up in spite of the challenges we all faced including the war, fuel prices in our case in the east unusually severe winter weather that put considerable pressure on our operations and expenses and also importantly sometimes slowed our customers as well.
Still in all of this we produced solid results even with abnormally weak coal traffic about which I'm sure Ike's going to talk at length later.
Basically, I would say that the first quarter showed the strength of our new schedules and systems and our continuing commitment to grow the business from the highways even when things are not so good.
So the story is we improved revenues and held the bottom line and even though we failed to improve our operating ratio for the first time in two years, we'll show you the reasons for that in a minute.
Our safety record improved 8% over our own industry best even in the tough operating conditions we faced this quarter.
So we're proud of that.
Looking briefly at the numbers and Hank will go over them as you know in detail in a minute, our income from continuing operations before the required accounting change, which we'll explain to you, but our numbers our income before that accounting change was $85 million or 22 cents per diluted share which was about the same as last year's results.
First quarter net income all in was $209 million or 54 cents a share, but that included the $114 million or 29 cents a share, which was largely due to the accounting change related to the cost of removing railroads cross ties or $10 million or 3 cents per share gain from discontinued operations resulting from the resolution of taxes related to the sale of North American Van Lines.
Now, I had hoped for the sake of simplicity that we would not be having to report on the discontinued operations front but I can hardly complain about 3 cents of additional income and cash related there to.
So Bill Galanko has told me to stop complaining and just get used to reporting this little item from discontinued operations and it is in there.
That's 3 cents of additional income.
Our results overall were achieved in spite of historically high fuel costs that were in excess of what we were able to protect with hedging and we will talk to you about our hedging program in a minute and with other higher than normal costs which Hank will also show you some details on.
So we did have some cost issues in the quarter.
But we continue to be intensely focused on improving our service reliability and our overall train performance has picked up from some early year slow downs to about 82% on time and improving.
Our operating metrics continue good and while Stephen Tobias is not slated for formal remarks this time, I'm sure he'll be glad to respond to any questions you have about our operating metrics.
For the first quarter I think it's especially significant that our railway operating revenues were $1.56 billion, that's 4% higher than the comparable period last year.
While our car loads were up 3%.
This improvement was largely driven by general merchandise revenues which set a first quarter record and were up 6% compared with the same period last year.
In fact, all of the general merchandise commodity groups exceeded their first quarter 2002 results.
Intermodal revenues during the first quarter were up 7% primarily as a result of strong international container volume which was up 8%, while container revenues climbed 12%.
The strong performance of the general and intermodal revenues in a quarter like the one we just finished is to me an encouraging sign.
As I mentioned earlier, we saw a slight decrease in coal volume in the quarter, which was down 1% compared with last year, but we have some indications that the coal volumes may be improving over the balance of the year and Ike will talk to you about that.
So as a result of the challenges that we faced this quarter, some of which I mentioned, there was considerable upward pressure on expenses and, indeed, our railway operating expenses for the first quarter did increase 5% compared with the same period last year.
Now, this was largely driven by fuel costs which have already begun to drop and we anticipate oil prices to continue to stabilize as the year progresses.
Additionally, we had unusually extreme weather conditions in the east in January and February, and February, which led to increased costs and also contributed to several derailments and associated costs from this.
These are all part of railroading and I am not complaining about it but as you know we are working hard to improve expenses and productivity so we at Norfolk Southern focus on any increases we do see.
We had a tough expense quarter and operating ratio for the first quarter was 85.2 compared with 84.2 last year.
This represents the quarter over quarter increase that we've reported to you in three years.
That is something that I never, I emphasize never, like to report but I assure you that the time is just as committed to improve our operating ratio as before and will continue to remain focused on incremental improvement going forward.
As we look to the second quarter and to the balance of the year, we're somewhat optimistic about the economy.
I don't believe anybody really knows what will happen giving the war and the continuing slow economy, albeit the signs of recovery that we've seen recently.
However, I can report to you that up to the east at her weekend in April despite everything overall car loadings up 2% year-over-year and all commodities groups, including intermodal and coal are showing positive volumes for us in April.
You'll recall last year's second quarter was relatively strong so improvements on that will be good.
But the strength we saw in a difficult first quarter and a return of more normal coal business makes us cautiously optimistic for the balance of the year.
We are hearing from our customers that if we can continue to offer the improved service schedules and results we can expect to continue volume growth.
Two of our large Norfolk Southern customers, Toyota and Coors, recently recognized Norfolk Southern for our service excellence in 2002 and we expected to continue on that in 2003.
So on the whole, while I can't really say exactly when the economy itself is going to begin to improve, I can tell you that we're optimistic that we will see continuing improvement in the second quarter and our volumes, operating revenues and continue to see efficiency gains.
Most important the performance you've seen so far demonstrates that we have the robust operating systems and capacity to handle the upturn.
In our continuing NS-21 and Six Sigma efforts will help us regain our momentum on margins.
So we're feeling all right and I'll -- I'm looking to continue to making progress on business growth, efficiency improvements, and better service throughout our transportation network.
I will ask Hank Wolf now to review our numbers for the first quarter and then Ike will tell you about the specifics of our markets and then after we've done that, as customary, we will all return and take your questions.
Hank.
Hank Wolf - CFO
Thank you, David, and good morning.
Thank you for joining us.
As David indicated, the first quarter was challenging for us.
We faced combination of concerns about the war and winter storms that impacted our costs.
We are hopeful that a successful post-war transition will improve consumer confidence and ultimately increase economic growth.
Oil prices have already started to decline and should become more stable as the year progresses.
There are several items that impacted our reported earnings that I need to call to your attention.
In the first quarter, we recorded a total credit of $114 million to reflect the cumulative effect of two changes in accounting principles.
First effective January 1, 2003, together with all the other rail companies, we adopted SFAS number 143, accounting for asset retirement obligations.
Under which the cost to remove rail cross ties must now be charged to expense in the period that the asset is removed.
Previously, this cost had been a component of depreciation.
Second, in January we implemented FASBE (ph) interpretation number 46, entitled consolidation of variable interest entities, which requires us to improve lease locomotives on the balance sheet together with their associated debt.
Previously these locomotives had qualified as off balance sheet obligation then you may recall we entered into that lease into the year 2000 when we leased about 140 locomotives.
In addition, we recognized a gain from discontinued operations of $10 million or 3 cents per share which resulted from the resolution of certain tax matters related to the 1998 sale of North American van lines.
For purposes of my presentation this morning, I'll focus my discussion on our first quarter results excluding these three items in order to provide a more meaningful comparison to last year.
Railway operating revenues for the first quarter were a record $1.56 billion, $63 million or 4% more than our operating revenues for the first quarter fourth quarter of last year.
Total car loads for the first quarter increased by 42,000 units or 2.6% compared with last year, principally as a result of higher intermodal and general merchandise traffic that was partially offset by very slight decrease in coal traffic.
In addition, revenue yield increased 1.6% which when combined with the volume increases resulted in a 4.2% improvement in railway operating references, and Ike will provide you with the details of that in a moment.
Railway operating expenses for the first quarter were $1.33 billion an increase of $69 million or 5% compared with last year.
The largest increase was in diesel fuel expense which increased by $23 million to $104 million compared with $81 million last year.
The higher diesel fuel costs were driven by an increase of 19 cents in the average price per gallon.
The average price per gallon rose by 28% from 67 cents per gallon in the first quarter of 2002 to 86 cents to the first quarter of this year.
Concerns about the interruption in supply of oil as the likelihood of war in Iraq increased drove diesel fuel costs to record eye levels during this quarter.
Our consumption was essentially flat at 121 million gallons.
Our diesel fuel hedging program helped us to mitigate the pressures of rising diesel fuel prices in the first quarter.
The hedge his that we had places produced a net savings of approximately $26 million in the quarter.
We hedged approximately 75% of our first quarter diesel fuel requirements.
The second, third, and fourth quarters are 77%, 69%, and 58% hedged respectively.
As you can see, we hedged a little over 91 million gallons of fuel in the first quarter and have approximately 93 million, 80 million, and 73 million gallons hedged respectively in the second, third, and fourth quarters.
The average price per gallon on the hedged fuel ranges from 77 cents in the first quarter to 74 cents in the second and third quarters.
Material services and rents increased by $21 million or 6%.
Purchase service costs increased by $10 million as a result of higher intermodal expenses and other volume related services.
Materials costs were $9 million higher than last year principally due to locomotive repairs.
Volume related equipment rents increased by $2 million.
Casualties and other claims expense increased by $16 million.
The increase was due to adverse personal injury claims development, equipment and laiding damage caused by derailments and increased insurance costs.
During the first quarter, we experienced extreme weather conditions the likes of which we had not seen in about a decade.
Despite the adverse weather, our employees kept the system operating but, unfortunately, the severe weather conditions led to increased costs and contributed to several derailments.
The derailment costs included equipment repairs, track repairs and payments to customers for laiding damage.
However, with our commitment to safety and thanks to the skill of our employees, we were able to avoid any serious injuries in connection with these incidents.
Other expense was $12 million higher than last year.
As you may recall, the first quarter of 2002 benefited from a property tax settlement that reduced expenses by $9 million and a $4 million recovery on a bad debt that had been written off.
Compensation and benefits increased over the same period of 2002 due to lower pension income, higher wage rates and increased health and welfare benefit costs but were largely offset by lower stock base compensation and lower payroll taxes.
In contrast, Conrail rents and services decreased by $6 million or 5% in the quarter principally due to lower shared asset area costs and higher equity earnings of Conrail.
The improvements in operating revenues were offset by higher operating expenses and produced a first quarter railway operating ratio of 85.2% compared with 84.2% last year.
Income from railway operations for the first quarter despite the challenges I mentioned earlier, was $231 million, only $6 million or 3% below first quarter 2002.
Total other income and expense for the first quarter was expense of $106 million compared with an expense of 1$00 million in 2002.
Gain on sales of property and investments was $5 million compared with $28 million in 2002, a decrease of $23 million.
As you may recall, the first quarter of 2002 benefited from a $10 million gain on the sale of an investment and $9 million for in other property sales.
Coal royalties were $9 million for the first quarter compared with $13 million for the same period last year.
A decrease in production was the principal driver of this decline.
Accounts receivable sales fees were $1 million less than last year.
All other was income of $7 million in the first quarter compared with expense of $6 million last year.
Principally due to reductions in deficiency interest attributable to favorable income tax settlements.
Finally, interest expense on debt was $127 million or $7 million lower than last year.
First quarter income before income taxes remain was $125 million compared with last year's $137 million.
A decrease of 9%.
The provision for income taxes for the first quarter was $40 million compared with $51 million last year.
And the effective tax rate in the first quarter was 32% compared with 37% in the first quarter of 2002.
The reduction in rate was due to a favorable resolution of prior year's tax provisions as well as higher equity earnings in Conrail.
For the first quarter, net income was $85 million, slightly below the $86 million generated last year.
As a reminder, our reported net income included the $114 million from accounting changes and $10 million from discontinued operations is $209 million.
This charge summarizes our results this last year compared with last year.
As you can see, the $63 million improvement in operating revenues was more than offset by $69 million in increased operating expenses.
Other income net declined by $13 million while interest expense on debt was $7 million, less.
Income taxes were lower by $11 million, resulting in $1 million less in net income.
Our earnings per share for the first quarter were 22 cents, just even with last year.
Again, our reported earnings per share including the impact of the accounting changes and discontinued operations were 54 cents.
Thank you for your attention and now I'll turn the program over to Ike Prillaman who will give you an in department report on depth report on our revenues.
Ike Prillaman - Chief Marketing Officer
Thanks, Hank, and good morning, everyone.
As David and Hank have mentioned, there were significant head winds during the first quarter and this certainly included slowing industrial production, a decline of consumer confidence along with higher energy prices and bad weather in each one of these factors do affect one of our business units or more.
In spite of these negative indicators, our merchandise and intermodal sectors produced improved year over results while our coal business showed strong recovery in March.
This followed harsh winter conditions and dismal car loadings in January and February.
And without making a prediction, I will say with continued success in Iraq and current spending levels of the federal government and many experts, if anymore you can find them, believe the economy will accelerate its growth from a current pace of about 2% to a range of 3.5 to 4% later this year but I would add that the consumer does bear watching.
First quarter did begin slowly and our January and February comparisons were not up to our expectations.
However, during March we saw a turn around in all traffic with an increase of over 37,000 carloads representing a 12% year-over-year increase in coal volume, a 7% increase for intermodal and 4% for merchandise.
Looking at the quarter in total, volume increased 3% or nearly 42,000 loads over the first quarter 2002, with gains in most all of the sectors except metals, construction, and coal.
Intermodal achieved its highest first quarter of as a result of a surge in international business and which increased 12% or 29,000 units.
For the first quarter, revenue reached $1.56 billion and that's an increase of $63 million or 4%.
Both merchandise and intermodal reached their highest first quarters ever.
The month of March was also the highest revenue month ever for NS.
Merchandise revenue reached $918 million, a $49 million or 6% improvement over the last year with each of the merchandise groups experiencing gains that range from 4% to 8%.
Intermodal revenue of $289 million exceeded first quarter 2002 by $19 million or 77%.
Overall, the fuel surcharge added $10.7 million to our total first quarter revenue.
Coal revenues of $354 million were down $5 million or 1% and compared to the past three years, revenue for the first quarter was relatively weak and certainly did not approach the first quarter of 2001.
Coal revenue per car of $895 was 6% -- excuse me, was $6 below first quarter of 2002 and decline was principally the result of increased short haul business.
Year-over-year or profitable short haul traffic increased 83% in volume and does continue to affect our year-over-year revenue for car comparisons.
This 20,000 carload increase in the first quarter reduced revenue per car by $38 when similarly compared to 2002.
Looking at the specific coal markets utility volume exceeded first quarter 2002 by 3800 carloads or 1%.
The cold weather had both positive and negative effect on our volume.
The severe weather resulted in coal plants running at peak capacity throughout the quarter while this same weather led to frozen coal which resulted in loading and unloading delays.
Increased Lambert's point volume did not offset the decline and steam experts through ballot lore more decline by 2300 carloads or 6%.
Exports from Baltimore declined nearly 60% compared to last year.
During the first quarter of 2002 there was strong sort volume through Baltimore due to the weak domestic market for steam coal.
In 2003 our largest producer has experienced short falls which limited availability for export.
While the volume at Baltimore was down 7300 carload, Lambert's point volume exceeded first quarter 2002 by 5300 car loads or 23%, and I will comment on the expert metallurgical market in just a moment.
Domestic metallurgical coal declined by over 2500 carloads or 9% compared to last year.
The late season opened later than expected due to frozen conditions and we expect this volume to be made up as the second quarter progresses.
We remain very bullish about the coal markets and our coal franchise.
Low first quarter production coupled with high usage has prompted utilities to begin aggressively replenishing their stockpiles.
In fact, it has been record reported first quarter on stockpiles exceeded 15 million tons which should assure a sustained higher demand for coal through at least September.
Increased electricity generation in the continued forecast of high natural gas prices and overall gas supply difficulties will also promote the increased coal production.
The decline of export steam goal through Baltimore will be offset by increased shipments to Mexico and the metallurgical expert contract negotiations have begun.
Overall we believe U.S. exports should exceed 2002 levels due to the decline of the world availability of coke and coals.
The coke shortage in the world market resulted in the increased foreign demand for US metallurgical coals, this includes country of more Morocco, Algeria, Bulgaria, Egypt and Turkey.
And recent years shipments of coal from the U.S. to these destinations are markets that have been limited.
Total intermodal volume increased by 29,500 units.
Increased by more than 31,000 units or 8% compared to first quarter 2002.
And looking at our specific markets, our international business was up 12% for the first quarter, included in the growth were increased military related moves and large movements of empty containers from our service area back to the west coast.
Our domestic international business grew as well, with volumes up 4% over first quarter 2002 and revenues was up 10% due to increases in the truckload sector.
Fuel surcharge and rate increases contributed to the double digit revenue growth.
For the quarter, Triple Crown volumes were down 1% compared to last year.
Adverse weather and service conditions impacted Triple Crown during January and February.
And also a key auto assembly plant down for 31 days during the quarter.
Going forward, a significant new parts move began in late March and train performances improved substantially.
Finally, our premium business declined in the first quarter with volumes decreasing by 10% and revenues were down 11% versus last year.
The decline in premium business was due to a $25 million annualized loss of U.S. postal business to competitors including Amtrack.
Revenue per unit for the quarter for intermodal reached $500 and this is an increase of $9 over 2002.
Despite a successful rate increase in 2002, which was maintained and existed during the first quarter revenue per unit was slightly lower than anticipated.
This was primarily due to a change in traffic mix from increased international volume that allows more efficient handling but less revenue per unit.
Fuel surcharges during the quarter totaled $3.9 million and added about $8 to revenue per unit.
The decline of first quarter revenue per unit from the fourth quarter of last year was due to the seasonal premium package business which operates in the fourth quarter of every year.
Looking forward, intermodal volumes are largely driven by consumer spending.
Inventory build up played a role in our first quarter performance and forward momentum into the second quarter will be highly dependent upon the economy.
Having said that, our intermodal volume is up again for the month of April and I would also add that intermodal is not entirely dependent on the economy for growth as motor carrier cost and prices rise, we continue to see increased interest from customers to convert freight from the highway and NS intermodal converted 6500 loads from the highway during the first quarter and we expect this trend to continue.
As I previously mentioned, this was the highest first quarter for merchandise revenues and the chemicals group reached a similar milestone.
AG revenues were a record high for any quarter with a 6% increase in volume AG increased 12 million or 8% and reached $166 million, increases in corn, sweeteners and improvement and military traffic was up $2 million for the quarter.
Increased shipments of corn into the northeast and southeast feed markets continued as a result of the 2002 drought and the effect on these regions.
These shipments are expected to be strong until late September when the 2003 crop comes through the market.
We continued to expand our grain shuttle train program, replacement of the 50 car units with 75 car units has significantly improved service efficiency and revenue.
Recent new service product is expected to generate about 2800 carloads in the $4.6 million annual business.
Automotive revenue of $242 million exceeded 2002 by $14 million or 6% while car loads increased 2%.
Approximately 70% of the gain in revenue was due to Ford's Michigan truck plants reduced production in 2002 for the pre-build of the 2003 model.
And during the first quarter of 2003, this year, Michigan truck was in full production.
Despite high dealer inventory levels, manufacturers did continue with planned production in the first quarter of 2003.
The weak sales during the quarter did prompt Ford and General Motors to announce production cuts in the second quarter of 17% and 10% respectively.
For 2003, some of these announced production cuts had already been planned and current forecast for production of 15.9 million units is down 300,000 units or about 2% from the original 2003 production plan and down 500,000 units or 3% from 2002.
Several projects with new business will help offset these production cut backs.
Mitsubishi in Normal, Illinois, Toyota, Princeton, Indiana, and Honda at Lincoln, Alabama had planned expansions or new plants coming on line while southeast Toyota at Jacksonville ramps up its new and larger distribution center.
Chemical volumes rose 3% while revenue reached $194 million, increasing $8 million or 4% over last year.
Improvement was the result of increases in industrial intermediates and plastic shipments.
In 2003 the chemical business remains dependent on housing starts and auto production and other consumer products.
However, recent declines in the natural gas prices have reduced the industry's cost pressures that they were incurring.
Following numerous plant closings and consolidations, our patron forest products business has experienced 3 consecutive quarters of favorable year-over-year comparisons.
Revenue of $150 million exceeded the first quarter of 2002 by $9 million or 6%, while carloads grew by 1%.
New services are slow but improving market condition for the paper industry and also modal conversions contributed to the increase.
In the pulp board led the volume gains for the group which business converted over from truck.
And we had about 5.8 million conversions from truck to rail for the paper business.
And despite flat car load comparisons, metals and construction revenue grew $6 million or 4%.
Coal and scrap metal grew from mill restarts and increased export demand.
However, this was somewhat offset by reduced import slab Volumes and domestic billup (ph) shipments.
Coal business was up over 15% in carloads and 20% in revenues for the quarter and this is hard to believe but coal exports continue to grow because of increased demand for steel from China and we're also continuing to divert the domestic coal business from truck.
Our construction markets were down during the quarter and this is primarily due to lower spending for highway projects by the various states.
Revenue per car for the first quarter of 2003 was the highest ever for merchandise reaching 1,360 or up 3%.
The fuel surcharge added $5.3 million to merchandise totals.
However, pricing and increased lumber haul longer haul business were the major drivers in the improvement.
Revenue per car up 5% when compared to 2001 and 11% when compared to 2000.
Paper attained the largest gain in revenue per car increasing 5% last year and that's as a result of a favorable mix along with price increases in fuel recovery.
Automotive revenue reached increased $53 due to the mixing center redesign which took place in 2002 and change in traffic mix toward the longer haul shipments.
Metals and construction revenue per car was up $37 over the first quarter of 2002 and the gains here were due to a combination of rate increases and longer hauls.
And chemicals achieved its highest revenues per car $1,017 increased longer haul, propane gas traffic and longer haul to sulfur reopened to a fertilizer plant in Florida.
And revenue as I mentioned before increased $16 because of the longer haul corn to the southeast feed mills.
To conclude, we are hopeful that first quarter is harbinger for 2003.
Or line of business depends on the performance of the economy on the strength of improved operations, new products and increased yield.
The quarter ended with low utility stockpiles and increased demand for coal through perhaps the end of the third quarter, and more over all the industry groups had positive results and low offsets.
We continue to focus on modal conversions on an annualized basis. 37,000 loads converted to load during the quarter and approximately $18.6 million in revenue.
Thank you.
David Goode - Chairman, President and CEO
Thank you, Ike.
That's a lot of detail but we are now prepared to take any questions you have.
Ken Hoexter - Analyst
Good morning, Ken Hoexter from Merrill Lynch.
Just a couple of questions on first on insurance claims.
It sounds like Hank quickly mentioned some of the claims had increased.
Is that due to, you know, higher payments on a per case basis or is there some trend there that you want to talk about?
Secondly, the employees were down about 650 in the quarter.
Can you give a target for the year if you have a target.
And then, third, Ike mentioned restocking some of the inventory levels at coal because they're going to start to restock some of those inventory levels and that should carry some demand until September.
Our understanding is that the inventory levels were coming down and staying down because your service was getting better so there was no need to keep as high of an inventory anymore.
Can you talk on that subject as well.
David Goode - Chairman, President and CEO
You want to start with doing it in reverse order.
Ike can talk about coal.
Ike Prillaman - Chief Marketing Officer
We estimate that the average stockpile inventory level is about 25 days now, that compares in the past which have been brought down, Tom, to 55 days.
We -- some of that included in that 25 day average or some utilities in the single digit area so there is a lot of restocking in process right now.
Stephen Tobias - COO
You want to take the claims and then I'll do employees.
Hank Wolf - CFO
Ken, during the quarter our casualty and other claims was $51 million compared with $35 million last year.
The one graphic I gave you that reflected the derailment costs account for $10 million of that $16 million difference.
The other $6 million is as a result of volatility that we've seen in some claims resolution that drove the actuarial projections to increase.
Now, obviously, we reviewed that every quarter and I can't tell you that that's something that is symptomatic.
But it is something that we are obviously going to have to watch going forward and I'm hopeful that we will see that moderate because the safety record is improving.
Stephen Tobias - COO
We got the lawyers working even harder, I hope.
On the employee, I think, Ken, I normally do not give you goals for that -- for our employee employment count.
I will say that as you have noted we have made substantial reductions in overall employment as a result of our productivity improvement process and we hope to continue being able to do that but our employment levels for the balance of the year are going to be largely dependent upon business conditions.
I hope that recovers so that we don't -- so we don't need to see large reductions in employment.
What I would like to see is a need for a lot of train and engine employees over the balance of the year and we have -- we have invested considerable effort in bringing new people onto the train and engine ranks as a result of the retirements we have seen from the new railroads retirement program.
We have a lot of substantial number of people in that training program that are reflected in employee accounts now and we hope to be keeping them very busy as the balance of the year remains.
Tom Wadewitz - Analyst
Yeah.
Hi, Tom Wadewitz from Bear Stearns.
As kind of a further follow up on the comp and benefits.
If you look at it on a per worker basis, it was I think up around 3% year-over-year, that's a lot better than it had been last year when you were running 6% to 8% per worker.
That largely just the health care costing being a little less pressure and do you expect that to continue, you know, 3% per worker type of range throughout the rest of this year and I have a question for Ike as well.
Stephen Tobias - COO
Hank, I'll answer that.
I don't know that I have enough data to give you a projection and how that'll run for the rest of the year.
What you're satisfying in the compensation and benefits line is a combination of the we do have some increases built in for the contract which we anticipate will be final here shortly.
So that is built in, obviously, to the numbers that we have so far we also have some incentive compensation that results were relatively good so that's reflected in that number.
That all gets folded in to the overall number and I think it's -- as I've said before, our general strategy is to keep that line relatively flat as a result of productivity increases along the way and that continues to be our strategy so we hope we can hold that percentage increase relatively low as it was in this quarter.
Tom Wadewitz - Analyst
Okay.
And then --
Stephen Tobias - COO
I think that's maybe the best I can do in a way of a non-prediction.
Tom Wadewitz - Analyst
Sure, that's helpful.
Thank you for that.
Two quick ones for Ike.
When you look for the mix of big three business down year-over-year and you have some new business coming on from the transplant can you give us any sense or autos is the net impact up second quarter?
Down second quarter?
Roughly speaking.
On the chemical side, natural gas have come down a lot from the peak but still, say, 5, $6 per million BTU relatively high compared to historical levels.
Are the plastics plants you serve competitive if we stay in that 5$ to $6 range.
Ike Prillaman - Chief Marketing Officer
First of all, Tom, to stay within the rules I need to call you Ken.
But the chemical business I think a lot of pressure has been taken off now.
You know, the chemical industry has a lot of the chemical companies have parents are in the oil business so really a mix when energy prices go up.
But I think this has taken the pressure off and they will remain competitive.
We have not seen and I have not heard of any imports making their way into the country for plastics, certainly not an expert on it, but it is so custom made that for their customers that I believe they're not happy but they're doing okay.
Tom Wadewitz - Analyst
On the auto side.
Ike Prillaman - Chief Marketing Officer
The auto side, you know, that's pure speculation but we are going to have some good offsets for any of the production cut backs.
What our traffic is showing so far is that, you know, year-over-year we are not incurring those offsets because it all depends on your products within that line.
I mean, if you're serving plants with a hot product, you will continue to do well whereas if you have some of the passenger vehicle plants, you are going to incur more short falls over the year.
Most of our plants are producing the vehicles that are in demand.
So I think we're in good shape for the fall.
David Goode - Chairman, President and CEO
I just reached down and found a dime on the floor.
I hope that's a good sign of things to come for the year.
It's in line with our philosophy, we will pick it up wherever we can find it.
Yeah, Tony.
Unidentified Speaker
David, I was wondering if you could update us on the ECBU and if you could what's your current appetite for either asset disposal or acquisition in short lines and regional because there is some for sale out there.
David Goode - Chairman, President and CEO
We've been very pleased after about a year with the progress of the east Carolina business unit.
And it has achieved productivity improvements and we're still -- we're still working with achieving the revenue gains that we think are there as we're intensively managing that for some new business and taking some new business off the highways.
I think we are not quite ready to show you that in detail this quarter as a -- you know, as a free standing business but I would say that we've been pleased with the results of that.
We think we'll probably be -- we are looking at doing some more of that in some other areas and anticipate that we will probably do it.
As we always do, we are focusing on our lines to make sure that we are fully utilizing all of the infrastructure we have and where we are not fully utilizing it we are doing something else so we don't have unnecessary costs in it.
We do have an infrastructure team working.
I think on an ongoing basis you are going to see us making some modest trends in that.
At the moment we don't see any very large units that we're -- that we're looking at in the short run.
I think we just -- it's kind of three yards and a cloud of dust on that, Tony as we've consistently done.
We are looking at it, eliminating lines or short lining.
We think that we'll be doing more and more of what we have done in the east Carolina business unit.
Unidentified Speaker
How about adding lines?
David Goode - Chairman, President and CEO
We think most of our capacity improvements have been made.
We're looking at building the coal line in Pennsylvania which will, hopefully, will be finished this year, guys, next year I guess so that'll be in addition and we'll make some -- strategic where we can get them for business but I don't see any large additions at the moment.
Yes, Scott.
Scott Flower - Analyst
Scott Flower, with Smith Barney.
I was wondering if Steve might give up an update on the incremental on TOP and local service, where we are and what we might expect over the next three, six months might come out from TOP.
David Goode - Chairman, President and CEO
I think Steve can do that.
Stephen Tobias - COO
We expect lots of good things to come out in the next three to six months, Scott.
On first of April we turned on what we call LOPA, local operating plant adherence, and LOPA gives us some as you from our previous conversations gives us the ability to plan the actual switching that takes place in the local environment against what reality is, and to evaluate that on a go forward basis from the standpoint of how do we perform against that plan and measure that process.
Oddly enough, I think today we will cut in two other elements of that, car status and next train which it relates to our terminal operations.
We will have a visual representation of next train to those entities who are responsible for the handling and processing of cars in a switching environment.
Car status will give us the status of the car, give the people that are managing our yards a visual representation of what is the status of that car?
Is it on plan?
Is it out of cycle or out of the commitment that it represents and what actions need to be taken to fulfill that commitment.
Those two pieces are very critical to our ability to manage on a dock-to-dock basis and as I say we are cutting those on system wide today.
Local LOPA was cut on the first of last month.
Those are all very positive configurations on a go forward basis and we will have a large bearing on what we do in the next three to six months.
David Goode - Chairman, President and CEO
Our people are really excited about some of the things.
We have been working on this systematically over the last several years.
Scott, I see a very high level of excitement of our operating and marketing people and the things that we're doing this year so if it is as useful -- it turns out to be the return is as good as the people that are using it think it's going to be, we should have some exciting things to report to you.
Scott Flower - Analyst
One technical question.
Some sense on the tax rate, how much in the current quarter is relative to the disposition of that past years versus the Conrail operating income.
I know you worked to get it as low as you can from an effective standpoint but what we might be thinking on the average basis for the year from a book standpoint.
David Goode - Chairman, President and CEO
Bill Galanko would be disappointed if he didn't get to answer that question.
Bill Galanko - VP Taxation
The effect of the audit was a little more than half of the reduction from year-over-year.
The effective tax rate.
And in addition to that, there was a minor or modest increase in benefits in the tax credit area.
I would expect the effective rate to be made -- it's hard to predict.
There are a lot of moving parts.
Going forward if I had a guess somewhere in this range for the rest of the year.
David Goode - Chairman, President and CEO
That's about as straight, more than you've gotten from me as a tax lawyer in the old days.
Rich Hamrin - Analyst
Rich Hamrin (ph) from Orcus Research from capital expenditures what do you see going forward?
David Goode - Chairman, President and CEO
You want to take that.
Hank Wolf - CFO
We announced our capital budget of $809 million in December.
Obviously, the weather conditions in the first quarter probably slowed a little bit of that down but there's no reason to believe we can't stay largely on target with that on a go forward basis but I think it is too early to predict.
It'll be some number other than $809 million and I certainly don't believe it'll be more than that.
David Goode - Chairman, President and CEO
Yes.
Unidentified Speaker
Thank you, David.
Two questions.
I guess at this point you could say war, recession behind the company we are more optimistic about better times.
I hope so.
We addressed the revenue side.
If Ike is right and we are looking at 3.5 per cent growth second half of next year, what type of operating ratio will you be disappointed with?
David Goode - Chairman, President and CEO
Yeah.
That's artfully worded, artfully worded question.
I will certainly be disappointed if we don't over the years as a whole show -- you know, significant improvement in our operating ratio.
You know the goal that I set out to make it start with a seven and obviously to do that we will need some help from the economy on the revenue side of the equation so I hope that, you know, I hope we begin to get that during the latter part of the year because I believe we can continue to improve our operating ratio on the cost side.
Certainly there are some things that we think we can improve on in the second quarter vis-a-vis what you saw on the first quarter in the way of expenses so we think there's some -- there's progress to be made and we're -- and our NS-21 and Six Sigma efforts are devoted to continuing to make that progress on the expense side of the equation.
But the economy will help us a lot to get back to the kind of operating ratio that we want to that begins with a seven and we're going to do that but I am going to resist the temptation to make a prediction to you as to what it is going to be for the balance of the year.
We do -- you will remember that we did post an operating ratio in the second quarter last year that began with a seven and given all the conditions, obviously, that's a very tough boogie for us this year to work against.
On the other hand, as a CEO, I enjoy having a tough boogie to put up for our people to work to encourage them to improvement.
That's kind of the way we approach it.
We do expect to continue to achieve incremental improvement in that operating ratio.
Unidentified Speaker
Okay.
Thank you.
Second question, I guess the flip side of success, if that happens, we may see an increase in interest rates at some point along that time.
Currently, what percentage of the debt through swaps or whatever is tied to variable interest rates and how quickly could that be swapped over if we start to see rates increase for the second half of the year.
David Goode - Chairman, President and CEO
Do you want to take that?
Hank Wolf - CFO
About 86% of our debt is fixed rate, 14% is variable rate.
We are largely fixed.
We have one variable rate maturity this year, one early next year.
So I think we're in pretty good shape, vis-a-vis, an exposure to rate increases.
David Goode - Chairman, President and CEO
We have -- obviously, we have managed our debt as we managed a number of other things because we want to create stability and predictability for ourselves and we have not wanted to be exposed to a lot of rate fluctuation philosophically so maybe we haven't benefited from the past on low rates but our exposure to increases is fairly limited.
John Barnes - Analyst
John Barnes from Deutsche Bank.
Ike, in taking a look at pricing and especially in the intermodal product what we have seen in the truckers in the first quarter so far is pretty decent rate increases and it suggests that maybe the spread between rail pricing and truck pricing is widened further.
Do you think you are set up for a more aggressive posture towards trying to generate additional rate increases and especially in the intermodal traffic?
Ike Prillaman - Chief Marketing Officer
We should be and we are.
You're absolutely correct that the spread gets larger and one trucking company who has a large intermodal operation along with its truckload operation that I'm familiar with is fighting the same effort that there's even a spread between their intermodal business and their truck business and I think all of us are trying to bring that more in line.
We've got to convince the customer base out there with the -- about the reliability and once we do that, we are doing that, we are going to get better price pricing and it's under way.
David Goode - Chairman, President and CEO
And we are -- nobody is happier to see strong trucking prices as we are.
John Barnes - Analyst
Hank, on a follow up on variable rate deb.
Once those two maturities are paid down, what would the percentage be at that point?
Hank Wolf - CFO
It'll be probably somewhere in the range of about %11 or 12% variable.
Obviously, as we go forward and we have some maturities in the fixed, we may want to take a larger position variable but I don't think it'll be a very great position.
The maturities are on the record for you to see and as those maturities come up, we are going to try to make the best and most intelligent decision on a go forward basis.
David Goode - Chairman, President and CEO
Our strategy, of course, continues to be to try to pay down our debt as we -- as we go forward we continue to have our goals to reduce our overall debt so you'll hopefully as we do well operationally you will see us continue to implement that strategy.
John Barnes - Analyst
Okay.
David, lastly, can you give us any update on what you see in terms of the legislative front in DC, especially regarding tax fairness bills and repealing the diesel fuel tax and the like?
David Goode - Chairman, President and CEO
We continue to be optimistic that the movement on the repeal of the 4.3 diesel fuel tax.
We've waited for that for a long time and I'm -- I've always reluctant to be optimistic on that front because it's been so hard to do but we think that this is -- that this is probably the best opportunity we've had for a good time and our price unit people feel there's a good likelihood of that moving this spring.
On the overall tax front, we think that some of the tax fairness and the difference dividend changes will be positive for the economy as they would for us and we'd like to advance that, but my crystal ball is to what's going to move in congress is no better than yours.
Or anybody else's probably.
Back here.
Jennifer Ritter - Analyst
Good morning, Jennifer Ritter from Lehman Brothers.
Looking at the $18 million for the weather related costs, $10 million the sounds like was from went into the casualty expense but where did the other $8 million go which cost item?
David Goode - Chairman, President and CEO
Hank, do you want to take that?
Hank Wolf - CFO
Well, I could probably have John Rathbone and Stephen Tobias help me answer that question but, obviously, you have snow removal costs, you have brush clearing, your trains are slowing down so that you have more crew time, labor costs.
So it is kind of a collective across the board increase that you are facing as in assigns the weather causes the system to operate a little less efficiently.
Jennifer Ritter - Analyst
Right.
Okay, great.
David Goode - Chairman, President and CEO
One of the things we did, Jennifer, we made a decision in the difficult winter conditions we made a decision we had mate commitments on our train schedules, we've implemented our schedule network and commitments in customer service.
We operated to do our level best to fulfill those commitments and that was not free.
There was some costs and we think we regarded that as an investment in the future because we tried to send a message that we were going to -- whatever the conditions, we were going to do everything we could to maintain those schedules.
Jennifer Ritter - Analyst
Great.
My second question was on fuel or on coal.
Last at your analyst's day, part of the reason the utilities weren't asking for more coal in the first quarter because they were trying out their equipment that allowed them to switch between gas and coal and the warranty on that equipment was running out.
Could you give us an update, is it over.
Ike Prillaman - Chief Marketing Officer
With the last part of the question, we have been told by many that it is over, that a gas prices in February reached a level that it was no more -- no longer economically feasible to continue to do that and I think there were some obligations to run the facility for warranty purposes.
We know the utility that had that obligation they are now -- they have turned the gas units off.
Everything we're hearing is that they're stocking, restocking very seriously and they need to get their stockpiles up for the coming summer months.
David Goode - Chairman, President and CEO
Yes.
Gary Yablon - Analyst
Gary Yablon for CSFB.
Coal is better for the balance of year.
Can you talk about mix, how revenue didn't go your way for Q1?
How does mix feel for the balance of the year.
Hank Wolf - CFO
Most of us arithmetic, we will start coming up against easier comparisons.
I think the river serve utility coal started moving some in the second quarter last year and mostly in the third quarter so we will start showing improvements over those quarters because we built in otherwise we have some real increases.
The number I showed today that is a reconciling number back to what brought revenue to car down for coal.
If you add that number back, it shows the more normal increase that we're getting in our coal business.
We had several contracts signed last year that did include increases.
Gary Yablon - Analyst
Just one for Hank if I could.
Hank, on fuel surcharges, could you explain some of the mechanics and I guess what I am getting at is for the second quarter could it be possible when we add in the hedges, add in surcharges to the extent you might have surcharges compared with where fuel prices are today, could it end up being a net positive whereas in Q1 it ended up being a net negative?
Could we see a net positive in Q2.
Hank Wolf - CFO
I don't know, Gary.
I don't have an answer to that one.
I don't know where the prices are going to go, what impact the hedges are going to have.
I do know the fuel surcharges kick in when the fuel prices reach a certain level and are sustained there for a period of 30 days or more.
Gary Yablon - Analyst
Are there surcharges in right now?
Hank Wolf - CFO
Yes.
Gary Yablon - Analyst
There are?
For what percent of the business?
Ike Prillaman - Chief Marketing Officer
Around 30%, Gary.
If the fuel -- the price of west Texas crude drops below $28, those fuel surcharges will go off for 30 days.
But they are in effect and then about 18% of our business runs under RCAF provisions and, you know, as you know, there's a delayed increase there as calculated by the AAR and that will be going into effect on a go forward basis.
There you are.
Gary Yablon - Analyst
Okay.
Thank you.
David Goode - Chairman, President and CEO
Yes.
Unidentified Speaker
Can you talk specifically about the shared area operations, how that came out quarter to quarter, year-over-year.
David Goode - Chairman, President and CEO
John, can you do that?
John Rathbone - SVP and Controller
About $107 million and it came out a little bit better, I believe, than we had anticipated.
The operations are smoothing out and you have seen a continuous decline in the shared asset costs and we probably reached sort of the bottom of -- near the bottom of that now.
Unidentified Speaker
Okay.
That $107 million is made up of two parts, I think, shared area and the equity income in Conrail.
John Rathbone - SVP and Controller
Yes.
Unidentified Speaker
Can you break it out?
John Rathbone - SVP and Controller
No.
We normally don't break that out.
Unidentified Speaker
Very good.
Thank you.
David Goode - Chairman, President and CEO
We can but don't.
Any other questions?
You've been very patient this morning.
Thank you.
We look forward to seeing you next quarter hopefully with another good quarter.
Thanks.
Operator
Thank you, ladies and gentlemen.
This does conclude today's teleconference.
Please disconnect your lines at this time and have a wonderful day.--- 0