Norfolk Southern Corp (NSC) 2003 Q2 法說會逐字稿

Good morning.

I'm David Goode and on behalf of Norfolk Southern let me welcome this hardy group who have turned out on a rainy day for our second quarter 2003 analyst meeting.

I also welcome those listening to us on the phone.

I'm asked to remind our listeners and Internet participants that the slides of the presenters are available for your convenience on our Web site under the investors section.

This morning we have our, sorry to say our usual cast of characters.

What I mean is, representatives of our management team.

Our Vice Chairman, Ike Prillaman, Chief Marketing Officer is here, Steve Tobias, Chief Operating Officer, Hank Wolf, all here in the front row, along with John Rathbone, Senior Vice President and Controller, and Bill Galanko our Vice President of Taxation today.

Along with -- I didn't mean it that way, Bill, no.

I mean we are especially honored by the presence of our Vice President of taxation today.

Bob Forte, Vice President of Public Relations is here, along with Leeanne McGruder, who is, I hope all of you know, Director of Investor Relations, , and Debbie Malvin, Hank Wolf's assistant is in the back to keep us all straight.

Our second quarter results, as you will see, show a 15% increase in earnings year-over-year, and reflect the highest railway operating revenues in Norfolk Southern's history.

We produced these better results in spite of continued economic slowness in the quarter, and considerable downward pressure on some parts of our traffic mix and considerable upward pressure on costs in the quarter.

So against a challenging back drop, we did, however, operate the best service in our history.

And our board yesterday also approved an increase in the dividend, recognizing our continuing commitment to improving the returns to our investors.

For the second quarter, Norfolk Southern net income was

$137 million or 35 cents a share, compared with net income of $119 million or 31 cents a share in last year's second quarter.

For the first six months, the net income before the required accounting changes was $222 million, or 57 cents a share.

For the comparable period last year net income was $205 million or 53 cents per share.

And I remind you that all in the earnings per share were six months were 89 cents, which includes that first quarter effect of the accounting change.

But on a comparable basis, we have continued to improve results in a tough economic environment.

And we think the results demonstrate the strength of our operating plan, which is producing steady improvements in service levels.

During the quarter we handled the highest number of carloads ever, while we reported record on time service and reliability performance levels.

Steve Tobias will show you details of that in a few minutes

We maintained our focus on safety.

I want to quickly add in May our Norfolk Southern people earned an unprecedented 14 (inaudible) gold medal for employee safety.

We continue leadership in this area, and our safety numbers have improved again year-over-year again safety continues to be a great source of pride for everyone at Norfolk Southern

For the second quarter, our railway operating revenues, which were $1.63 billion were the highest of any quarter in our history.

They were up 3%.

For the entire first half, the railway revenues were $3.19 billion.

That's also up 3% compared with the same period last year and it's a six month record high for our company.

Some pieces of the pie were much better than others.

Our coal revenues climbed 11% in the quarter -- and were 5% better for the first six months.

The growth was driven mostly by increased utility shipments as power companies replenished their stock piles and seasonal weather conditions returned in our service territory.

But the export coal also showed improvement.

Intermodal revenues were up 4% for the first half, reflecting traffic growth from new truck competitive France Continental interline business is and strong international business for us.

We continued to emphasize truck conversions in all our lines of business.

We are having success with that

The general merchandise revenues of $944 million in the second quarter were weaker.

They were down slightly compared with 2002.

And for the first six months, general merchandise revenues increased 2% compared with 2002.

So obviously there's good news and bad news in the merchandise revenue sector.

The good news is that ag revenues strengthened by grain shipments posted the largest gain--that was up 12% in the quarter, and 9% the first six months.

We were happy to see paper and forest products were up 6% for both the second quarter and the first six months.

Ike will provide you with details on all these revenues in a few minutes.

I'll let him tell you about automotive and metals and chemicals, which didn't have quite as much good news.

Ike can talk about those.

On the expense side of the house, as you can see, we experienced considerable upward pressure and cost control is an area of serious focus for us going forward.

Our railway operating expenses increased 5% for both the second quarter and the first six months of 2003 compared with last year.

The increases are principally compensation and benefits; fuel costs; increased casualty and other claims as a result of our most recent actuarial study of claims reserves.

Hank will show you more details on this in a minute.

But with revenues up 3% and our operating expenses up 5%, the second quarter railway operating ration was 81.1, compared with 79.8 in the same period of last year.

For the first six months the operating ration was 83.4 compared with 81.9 for the comparable period of last year.

While the second quarter was better than the first, we are obviously not satisfied with the year over year increase in the operating ratio.

The operating ratio increase is something I never like to report to this group.

I assure you that the Norfolk Southern team has increased its commitment to improving the operating ratio and we are focused on continuing improvement as we go forward.

Let me take just a minute to address this with you.

I know it's a matter of interest and maybe concern.

We, like many others, anticipated that the economy would generally strengthen as the year progressed, and we made some of our plans and commitments on that basis.

While our service improvement, which you'll see from Steve in a minute, speaks to some great investments in this area, it's clear that we can't necessarily afford to assume a strong economy.

In the wake of continued uncertainty about this, we now have several initiatives underway to control costs and improve utilization and efficiency.

Over the past several years, our traffic mix has undergone a great deal of change.

It shifted to consumer oriented business like automotive and intermodal.

Much of this business is truck competitive and service sensitive business, which places increased pressure on our margins--and we recognize that.

At the same time, coal traffic represents low percentage of our total and our profitable export coal volume today is, as

all of you know, is a third of what it was a decade ago.

All of that relates to the changes that we have been making in our service network, our infrastructure and our operating plan, with the introduction of TOP, what we call the Thoroughbred Operating Plan, which adjusts to these changes in traffic mix and, which makes us more efficient and flexible while making our service much better.

Norfolk Southern has a great track record in reducing cost and increasing productivity.

We will reduce the cost, but we will not concede the service improvements that we've secured with our TOP plan.

TOP generated the most consistent service we've scene and it's a key factor in growing our business and making us more efficient.

Bottom line, our margins are under pressure.

You see the results this quarter, but at the same time, you can also see revenue gains and real service improvement.

We will fix the operating ratio, but it's even more important for us to make changes in the right way so that we don't damage the solid foundation we've built and jeopardize the opportunity for growth in the future.

We are initiating efforts to reduce costs, carefully appeared systematically.

First, we are eliminating unnecessary infrastructure.

Second, we are synchronizing now our local operations into the Thoroughbred operating plan.

This will not only improve service but yield efficiency gains and improved asset utilization.

You will be able when you look at Steve's numbers to see the consistent improvement as we continue to get TOP thoroughly into the system.

Third, we continue to reduce the size of our work force in order to offset the increased cost of compensation and benefits.

We are engaged in Norfolk Southern right now in an activity value added process, which is already underway.

The objective is to take work out of our processes, not just to reduce head count, although that will result from it.

In a way that will allow us to continue to provide improved service for our customers.

So as we look to the third quarter and the balance of the year, I remain extremely optimistic.

We are sticking with what we think is a good plan.

It produces additional efficiency gains and improves customer service.

We will continue to sell that service at a fair value added price.

We will exercise cost discipline across the board for the remainder of the year.

If the economy remains flat, the customers will need the cost effective benefits of good rail service.

If the economy begins to improve, the good news is we have both the capacity and the expertise to handle the up side.

We expect the service trends to continue, and we believe the economy is improving, although still slowly.

We can grow our business last quarter as we did, I'm confident we can do much better in improving market conditions.

So I would say that Norfolk Southern has done considerably better than hold its own throughout the tough economic environment.

We posted year-over-year improvement in numbers in a very challenging business quarter this quarter.

We will continue to improve our operations and focus aggressively on improving the revenue yield in all our markets.

And we are already ready for an upturn.

So now let me ask Hank Wolf to review our numbers for the second quarter in detail.

Then, as usual, Ike will talk to you about the specifics of our markets and Steve will talk to you about our operations and service numbers.

Then, all of us will be here to absence questions.

Hank?

Thank you and good morning.

Thank you for joining us this rainy morning.

A you will recall, in the first quarter, there were several itemes that impacted our reported earnings.

We recorded a credit of $114 million to reflect cumulative effect of two changes in accounting principles.

One under A FAS 143, accounting for asset retirement obligations, and

another under FAS-B interpretation number 46 of consideration of variable interest entities.

We recognized a gain from discontinued operations of $10 million related to the 1998 sale of North American Van Lines.

In order to provide you with the most meaningful comparisons to last year, I'll be excluding those items from the rest of my remarks this morning.

Railway operating revenues for the second quarter were $1.63 billion-- $40 million, or 3% above last year, with increases in coal and intermodal revenues partially offset by lower general merchandise revenue.

Year to date, railway operating revenues were $3.2 billion, an increase of $103 million or 3%, reflecting overall increases in each of the three major revenue categories-- general merchandise, coal, and intermodal.

Both periods represent our highest revenue levels since the integration of Conrail.

Second quarter carloads increased by a little more than 19,000 units, or 1.1%, compared with last year, due to higher coal and intermodal traffic that was partially offset by a decrease in general merchandise traffic.

Revenue yield increased 1.4% and combined with the carload increase resulted in a 2.5% improvement in railway operating revenues.

For the first half, car loads increased approximately 61,000 units, or 1.8%--a result of higher intermodal and coal traffic, while general merchandise traffic remained level.

Revenue yield was up 1.5% and revenues improved 3.3%.

And Ike Prillaman will provide you with the details of our second quarter and six-month revenues in just a moment.

Railway operating expenses for the second quarter were $1.34 billion, which is $64 million or 5% above 2002.

For the first six months railway operating expenses were $2.67 billion, which is $133 million or 5% higher than last year.

As you can see from this graphic, small reductions in other operating expense in Conrail rents and services, were more than offset by increases in compensation and benefits, material services and rents, casualties and other claims and diesel fuel expense.

Other expense decreased by $5 million year-over-year, largely due to a favorable resolution of property tax litigation in the State of New York.

Conrail rents and services were $1 million lower than last Year, due to higher equity earnings of Conrail.

And depreciation remained flat with last year.

The largest increase was in compensation of benefits Expense, which was up $38 million or 8%, compared with 2002.

Wages rose $13 million.

Health and welfare benefits costs added another $13 million pension income declined by $11 million.

Other items and increased hours worked more than offset the $5 million in savings from the reduction in the railroad retirement tier two tax rate

The second largest increase in railway operating expense was in materials, services and rents, which increased by $13 million to 4%.

The quarter over quarter increase was primarily due to a $10 million increase in purchased services stemming from higher haulage and software costs and $4 million more in materials for repairs and maintenance that were partially offset by a $1 million (inaudible) decrease in equipment rents.

The next largest increase in railway operating expense was in casualties and other claims, up $10 million or 27% due to adverse claims development and higher insurance costs.

Diesel fuel expense rose by $9 million or 11%.

Diesel fuel expense reflects a 14% increase in the average price per gallon, which is up to 80 cents from 70 cents in the second quarter of last year.

The average price per gallon would have been 87 cents per gallon but for a fuel hedging program.

Our fuel hedging program produced a cost of $8.3 million in the quarter.

In addition, we had a modest reduction in fuel consumption of approximately 3.3 million gallons.

We hedged approximately 80% of our second quarter diesel fuel requirements, and the third and fourth quarters are 77% and 68% hedged, respectively.

During the second quarter, we hedged just under 97 million gallons of fuel at an average price per gallon 74.2 cents.

We have approximately 91 million gallons hedged in the third quarter at an average price per gallon of 74.9 cents, and 84 million gallons hedged in the fourth quarter at 77.3 clients better gallon.

Railway operating expenses for the first six months were $2.67 billion, $133 million, or 5% higher than last year.

Again, the largest increases were in compensation and benefits, material services and rents, diesel fuel, and casualties and other claims.

Year to date compensation and benefits increase $41 million compared to 2002, principally as a result of $22 million less in pension income, $21 million more in wage rates, and health and welfare costs that were $20 million higher on a year over year basis.

These increases were partially offset by lower stock based compensation, and savings from the lower railroad retirement tier two tax.

Material, services and rents increased $34 million, or 5% , due to increased haulage, higher repairs and maintenance on locomotives and freight cars, and higher software costs.

Deisel fuel expense was higher by $32 million, or 19%, due to higher average price per gallon which increased from 69 cents pers gallon in 2002, to 83 cents per gallon this year.

Consumption decreased by approximately 2.2 million gallons, or 1%.

Casualties and other claims for the first six months increased $26 million or 36%, a result of adverse personal injury claims development, equipment lading (ph) and damage from derailments in the first quarter, and higher insurance costs.

Other railway operating expense increased $7 million, reflecting the absence of a bad debt recovery that we had last year.

Depreciation was level year-over-year.

Conrail rents and services decreased $7 million due to higher equity earnings of Conrail and lower shared asset area costs.

The railway operating ratio for the second quarter was 81.8% compared with 79.8% last year.

A two percentage point increase over second quarter last year.

For the first six months, the railway operating ratio was 83.4% compared with 81.9% last year, which is a one and a half percentage point increase.

Income from railway operations for the second quarter was $298 million, a decline of $24 million. or 7%, compared with last year.

For the first six months, income from railway operations was $529 million, compared with $559 million in 2002, a decline of $30 million, or 5%.

Total other income and expense for the second quarter was an expense of $99 million, compared with an expense of $128 million in 2002.

Gain on the sale of property and investments was $3 million higher than last year.

Coal royalties decreased by $2 million, due to reduced production.

And accounts receivable sales fees were lower by $2 million.

All other income of $7 million for the quarter was a $19 million improvement over last year, and that is due primarily to higher returns on corporate owned life insurance and reduced income tax deficiency interest resulting from favorable tax adjustments.

Interest expense on debt was $123 million, which is $7 million, or 5% lower than last year.

For the first six months, total other income and expense was an expense of $205 million, compared with an expense of $228 million in 2002.

Gain on the sale of property was $12 million, down $20 million on a year over year basis.

Last year we had the benefit of a $10 million first quarter gain on the sale of an investment, and $9 million more in gains on the sales of property.

Coal royalties were $19 million, down $6 million, due to reduced production.

And accounts receivable sales fees were $3 million lower than last year.

All other was income of $14 million compared with an expense of $18 million last year, primarily due to lower interest on tax deficiencies and higher returns and corporate owned life insurance.

Interest expense on debt was $250 million for the first six months, down $14 million due to lower interest rates and less outstanding debt.

Second quarter income before income taxes was $199 million compared with $194 million last year, a 3% increase.

For the first six months, however, income before income taxes was $324 million compared with $331 million in 2002, a 2% decline.

The provision for income taxes for the second quarter was $62 million, compared with $75 million last year.

And the effective tax rate in the second quarter was 31.2%, compared with 38.7% last year.

For the first six months, the provision for income taxes was $102 million, compared with $126 million last year.

And the effective tax rate was 31.5%, compared with 38.1% last year.

The lower effective tax rate for both periods was primarily due to the favorable resolution of prior years tax liabilities as well as higher equity earnings of Conrail.

For the second quarter, net income was $137 million, 15% higher than the $119 million reported in 2002.

For the first six months, net income was $222 million, which is 8% percent over last year's $205 million.

This slide highlights the components of the changes in net income year-over-year.

For the second quarter, while railway operating revenues were up $40 million, railway operating expenses were $64 million higher, producing a decrease in income from railway operations of $24 million.

Our other income net was $22 million higher.

Interest expense on debt declined by $7 million.

And income taxes decreased by $13 million resulting in $18 million more in net income.

Year to date, income from operations declined $30 million as $103 million increase in railway operating revenues was more than offset by the $133 million increase in year to date railway operating expenses.

Other income net was $9 million higher.

Interest on debt was $14 million lower.

And income taxes were $24 million lower than last year, resulting in a $17 million increase in net income.

Earnings per share for the second quarter were 35 cents compared with 31 cents per share in 2002, a 13% increase.

For the first six months, earnings per share were 57 cents, which was 8% percent above the 53 cents per share earned in the first six months of 2002.

I want to thank you for your attention.

Now I'll turn the program over to Ike Prillaman, who is going to give you an in depth report on our railway operating revenues.

Thank you, Hank.

Good morning.

In spite of most projections, the recovery of the US economy remained very reluctant during the quarter.

The Institute for Supply Management Index, which is for manufacturing rose from 45.4 in April, to 49.4 in May, and increased marginally in June.

Consumer confidence also increased, but well under the levels of one year ago.

However with increased government -- and I would add, perhaps to only the imagination of John Maynard Caines (ph) -- interest rates at the lowest level in 45 years, and reduced taxes on personal income, it would appear that there is a compelling case for stronger growth in the last half of this year and 04.

Our first quarter concluded with a significant increase of volume in March, and this carried over as the quarter began with overall strong year over year comparisons for April.

However, as you can see, May and June were essentially flat.

Total volume of 1.73 million represented an increase of 19,000 units, or 1% over second quarter 2002. (inaudible) Specific markets were highly variable in the second quarter.

Continued lag in industrial production effected merchandise comparisons, even in April, as volume declined 16,000 car loads, or 2% as a result of reduced steel and auto production.

Intermodal produced record results during the quarter, however, these results were challenged due to comparisons against a strong 2002 and a decline in premium traffic.

And coal carloading increased significantly as there was a push to replenish the stockpiles.

Trafic levels were up throughout the quarter, and increased nearly 27,000, or 7%.

For the second quarter, revenue reached $1.63 billion, and that is our highest revenue quarter ever, which was an increase of $40 million, or 3%.

For the first half of the year, revenue was up $103 million--also 3%.

And as with volume, intermodal revenues were the highest ever for a second quarter, and exceeded 2002 by $5 million.

And for the year to date revenues were up $24 million.

With a 7% volume increase, coal revenues increased grew $39 million, or 11%, while year to date revenue was up $34 million.

The five industrial sectors of merchandise generated $944 million in the quarter, which is $4 million below last year, but $45 million, or 2% above last year for the first six months.

And there were significant year over year changes for the second quarter.

Revenue gains of $19 million in ag and $8 million in paper and forest products, were offset by a $31 million decline in metals and automotive revenue.

Both were down by 7% while chemical revenues were flat.

Looking at each market, our ag and consumer products business generated record revenue for any quarter--up $19, or 12%, and was up 10% for the first six months.

And continued movement of long haul corn into the Southeast feed market and increased fertilizer traffic drove the favorable results.

We do expect these favorable trends to continue through the second half.

Our paper and forest products business continues to steadily improve and we achieved our fourth consecutive quarter of year over year results.

Revenue for the quarter increased $8 million, or 5%, while year-to-date revenue was up $17 million.

While improving market conditions contributed to these results, we think it's encouraging that $6 million of the first half revenue gains for paper were generated from truck diversions.

Looking ahead, we are cautiously optimistic that further market improvements and year-over-year growth will continue during the second half of 2003.

And conversion of the truck to rail will be key to further growth in this group.

Chemicals revenues were flat, compared to second quarter 2002.

While year-to-date revenues were up 2%over last year.

Lower demand and higher inventories of plastics developed as automotive production and housing starts slowed in the second quarter.

Looking forward, growth is projected to be flat.

That again is as a result of the housing and automotive markets.

But also coupled with the severe impact of increased natural gas costs for chemical production.

Chemical plant production levels dropped to 74% during the quarter.

This is due primarily to the feed stock cost factors.

Accordingly, imported chemicals are projected to increase by 5% this year after a 9% spike in 2002, as the feed stock cost continues to drive some production offshore.

And our growing business at several import export terminals reflect this trend.

Metals and construction revenue for the quarter declined $14 million or 7%.

Iron and steel shipments fell by 32% during the quarter as a result of declined in imported steel.

The imported slab market into the U.S. has been affected by a weaker dollar.

Significant purchase of slabs in the open market by the Chinese and increased domestic steel production from the reorganization of Bethlehem and LTV.

In the second half of 2003 we ran 86 fewer slab trains than the previous year and this equated to 6,500 carloads.

Conversion of highway movements of metals and construction materials helped offset some of this decline, and these conversions generated about $9 million in the quarter and $16 million for the first half.

And looking forward, it is believed that domestic production will increase, and the imported slab market will not return any time soon to previous levels.

I would quickly add that that means we get to do it the old traditional way where we haul the inbound raw materials such as iron ore, and coke and coal.

We do expect the highway trend to continue through the second half and into 2004.

Finally, automotive revenue declined $17 million or 7% in the quarter.

While year-to-date revenues declined by $3 million or 1%.

Vehicle production cut backs in model changeovers at key assembly plants made this quarter difficult at best when compared to record high automotive revenue of $259 million reported last year.

We estimate that second quarter revenue loss for the model changeover of the Ford F150 alone amounted to $7 million of lost revenue.

But obviously, that production will be made up in the third and fourth quarter as the dealers inventories restocked.

And G.M. production also declined due in part to tornado damage to their Oklahoma City plant and Daimler Chrysler's production was down over 8%.

Expanded production for Toyota, BMW and Honda helped offset some of the big three production declines.

Looking at the second half, we do expect increased shipments from Ford as the volume of 2004 F150s will ramp up for dealer delivery.

At G.M., the storm damaged Oklahoma City assembly plant reopened, and we expect higher shipments from a newly retooled plant at Fairfax, Kansas which will ramp up in August with the next model.

However, even with selected plants reopening and higher parts conversions from the highways, there are difficult year-over-year comparisons with 19 plant weeks of unscheduled down time in the third quarter of 2003 already announced.

As I say it again, this does represent a challenge for our third quarter.

For the year light vehicle sales are expected to be 16.26 million units.

That's down from 16.78 million units in 2002.

I would say 2003 is perhaps a good year, but just not good for comparing against 2002.

Merchandise revenue per car reached $1,334 for the quarter as $24 or 2% over last year reflecting a favorable mix.

Fuel surcharges and rate increases for the quarter, all of our merchandise groups produced gains with the exception of metals and construction.

Paper revenue per unit reached a new high as fuel surcharges rate increases and longer haul business contributed to the improvement.

Whereas ag revenue per car improved $51 over last Year, and this was the highest quarter ever for ag revenue per car.

As I mentioned earlier, the continued increases in long haul volume to eastern and south eastern feed markets drove the improvement.

Chemical revenue per car increased by $38, in part due to longer hauls, sulfur shipments and rate increases.

Metals construction volume declined from metals revenue per unit per carload declined from $966 to $954 primarily due to change in traffic mix.

Our higher revenue per car, steel slab, and machinery traffic, as I commented earlier declined during the quarter while construction traffic was even when compared with last year.

Looking at intermodal, our volume increased approximately 8,300 units or 1% for the quarter, while year-to-date volume was up 38,000 units or 3%.

Increases in international volume for both the quarter and year-to-date offset declines in the premium and triple crown volumes.

These positive comparisons were produced against an extremely strong second quarter of 2002 that included significant preshipping before the west coast work stoppage, which occurred in the middle of third quarter 2002.

Looking at our specific markets, losses in the premiums sector were due to a 31% decline in postal traffic and a decline in auto manufacturing which impacted triple crown second quarter volume On the up side, highway to rail conversions drove a 7.5% volume increase in the domestic truck load business, which offset declines in our domestic IMC business.

And our international business grew 8%.

Intermodal revenue per unit did not change year-over-year.

The fuel surcharges added $5 per unit.

This was more than offset by mixed changes of increased container traffic or international container traffic and a decline in the premium trailer business.

The intermodals market solid performance should continue into the second half of the year.

Both domestic and international traffic will be driven by traditional peak season this year, as compared to last.

And there will be easier comparisons After August we expect improved year-over-year comparisons because of the 2002 west coast work stoppage.

Beyond the economy, intermodal is well positioned for continued highway diversions, and the service we are providing to our customers reached an all time sustained high for both conventional network and triple crown, and Steve will tell you more about that in just a moment.

Our truck brokerage business which includes both conventional and triple crown traffic moved at record levels in the second quarter.

And the efforts that triple crown resulted in $5.5 million in new business.

Taking a look at our coal markets, new business and lower generation from gas, offset the declines due to unseasonably cool weather and reduced overall electricity demand during the quarter.

Stockpile rebuilding aldo helped to drive increases and new business continues to ramp up with the Sanlas (ph) First Energy plant and at Powhattan point for river served plants.

Utility stock piles in the northern service area continue to during the quarter due to cooler than normal weather.

We estimate that the majority of these have stockpiles at or near normal levels going into a summer generating season.

Stockpiles in the south are up only slightly due to wet weather and mild temperatures in April, May, and early June.

And the shipments in the third quarter will follow the weather and a number of cooling days.

We continue to monitor the national, natural gas market underground storage of natural gas is unusually low.

A shortage this winter could lead to significant price increases, which in turn would lead to greater demand for coal fired generation.

The new export year started April 1 and volume increased 4100 car loads for the quarter and 1800 car loads year-to-date.

And an increase in metalurgical exports through Lambert's Point in Norfolk more than offset the steam coal exports.

And we expect this trend to continue throughout the third and fourth quarter.

Our domestic net coal car loading shows some softening.

Actually, we are getting tons in the car, and tonnage is actually even with last year, which reflected improved loading efficiency, and as I mentioned earlier, we do expect more domestic steel production this coming quarter.

Last year, our coal business had a 34,000 car decline, of long haul utility and export traffic, while we picked up a large amount of short haul business with revenues less than $250 per car load.

We estimated that this traffic mix changed (inaudible) second quarter 2002 revenue per car by $50.

The change in traffic mix was again extreme for this year’s second quarter, but this time the results were reversed--the significant increase in longer haul, higher rated utility and export volume, produced a $55 increase in revenue per car load for the quarter.

And longer haul utility traffic into the southern region increased at a greater rate than longer haul into the northern reagion.

In summary, the economy remains uncertain, particularly, the manufacturing sector.

Even though the experts continue to project a stronger recovery.

We do have the largest motor vehicle and parts car load business in the rail industry, as well as metals.

Additionally, about 40% of Triple Crown’s business is automotive related.

And I would add that economic recovery, by history and definition, will and has always included the automotive industry, and the size of our franchise always offers opportunity.

We do have a balanced book of business, which played out for us in the second quarter.

As automotive (inaudible) and intermodal business slowed, our ag and coal markets that themselves had lagged in 2002, became very busy, and recorded $58 million in revenue growth during the quarter.

To conclude, we remain guarded but optimistic and now Steve will report on operations.

Thank you, Ike.

Good morning.

It's a pleasure to have you in attendance.

We appreciate your support.

Operationally, the second quarter 2003 was a very good one for NS.

Demonstrating the significance of our long-term potential of TOP and LOPA (ph) the local operating plant adherence systems.

After the weather related interruptions we experienced in the first quarter, we quickly put our train performance back on track.

As good as our performance has been, as David has mentioned, expenses and cost control have now moved to center stage.

This can be a delicate maneuver in view of our strides in customer service and heightened performance, but one I'm confident we will manage.

We will build on the superior service franchise at top and LOPA. have enabled our employees to create while keeping keenly focused on cost control, I'll lab rate in a moment on how we will do that.

First I would like to bring you up to date on our safety performance.

Typically during the summary months, we experience more injuries due to increased hazards, normal summer distractions, and inceased activity.

Ten years ago, however, we implemented a Summer Spike Awareness Program.

This has been quite effective.

So much so, that in June, typically a month in which our injuries have spiked, we produced our best results since 1999, with a reportable injury ratio of just .74 injuries for 200,000 man hours, or 18 injuries per month.

For the six months of 2003, our reportable injuries were a ratio of 1.23, a 6.9% improvement compared to the first half of 02.

We continue to work to achieve our goal of zero incidents and zero injuries.

Returning now to operations and service, let's look at our recent metrics.

I ask that you note the white line which shows 2003 performance.

Train speed for the weekending July 18 was 24.2 miles per hour, on par with last year's pop answer.

System terminal dwell (ph) belows 24 hours and stand at 21.9 hours, consistent with last year.

Since the first quarter, cars on line has returned to a pattern of improvement showing the effects of top and LOPA, as we continue to drive cars off our system.

Cars on line for the weekending July 18 stands at 179,000 or, .08% fewer than the same period last year.

As you may recall, we saw operational set backs during the first quarter of 03 due to extreme weather and a number of accidents.

For the second quarter we saw stronger signs of improvement when compared year-over-year.

Shown here in horizontal line, carloadings and train speed.

Importantly train speed for the quarter improved even as we experienced increased carloadings.

Again, with first quarter issues behind us, we were able to realize the benefits of our system improvements.

This chart shows across the board improvement among train categories.

By returning and running to plant we have improved our on time train performance over second quarter 02 to the following-- 93% on time for auto parts, nine point improvement; 89% for general merchandise, a Seven-point improvement;90% for intermodal, also a seven-point improvement; 95% for premium intermodal, a six-point improvement; 92% for multilevel trains, ten-point improvement; 85% for Triple Crown, 18-point improvement.

And overall 90% for all trains, an eight-point on time improvement for all merchandise in interval of trains operated

Our performance rebound since the first quarter is more evident in the trends since 2001 as shown here.

The dotted lip at the bottom indicates early origination.

The red line depicts on time origination.

The blue transit time and green reflects designation on time.

The vertical line represent milestone system improvements and other operational changes.

In our continuing efforts to reduce cost, top and LOPA. are making a huge contribution.

We are redesigning train service throughout our system using new information that will result in fewer trains and more predictable service tailored to our customers' expectations and needs.

The ongoing effort is a direct benefit of the expansion of our new systems and those that we are developing to complement them.

Plin reply our operating plant adherence system and our dynamic train service register.

We made a number of improvements in the first half that are indicative of our direction.

For example, we reduced total employment year-over-year by .08%, or 231 fewer employees.

Other similar trends year-over-year include carloads per crew start, an important measure of productivity rose 1.3%.

Gross ton miles increased 1.4% while fuel consumed fell 1.1%.

Gross ton miles per gallon of fuel improved 2.6%, and gross ton miles per gallon improved 4.5% in the second quarter.

Additionally, 73 locomotives have been released from operation an the ongoing locomotive utilization study.

We will save more than 4 million on -- we are looking at fuel saving technologies for locomotive shut down practices.

We are accelerating to plans to install more shut down devices

Our efforts continue as we have discussed previously to focus on yard operations, track structure appear density, and general and administrative, which includes an active value analysis of all non-agreement work.

If I could summarize everything into one sentence, it would be this-- We are intensifying our efforts to bring

expenses in line with revenue, while ensuring our train operations perform savely, efficiently and reliably as our customers expect.

Thank you.

David?

Thank you, Steve.

I know that's a lot, but we wanted to give you a good mid year report.

I'll now take questions.

If any.

Yes?

Thanks.

Couple of questions.

One, bonus depreciation in 03 and 04, did that change your cap ex plans at all?

Are there plans to accelerate anything to address that?

Want to address that, Hank?

John, we are taking a look at that.

We are not at the stage where we can say there's any change in the 03 or 04 plan.

For 03 we will stay on track with the budget plan that we have.

We may take a look at the opportunities that lie ahead in 04, but we haven't really gotten to that yet.

Secondly for Ike, on the bulk side of your business, you obviously saw improvement in coal traffic and I'm curious, is there any opportunity to, number one, exploit the production disruptions in the powder river basin due to flooding they have had there.

Number two, are you worried at all that some of the producers in the central appear latch Indians are keeping production limited because they are uncomfortable with current coal prices? (Laughter)

I don't know who is listening.

I think there is a scramble for availability right now.

And I do see an increased production needed as there is a decline in natural gas generation of electricity for the coming two quarters.

So far, that scramble has worked appeared no one is, and no one has ended up short.

It would be speculation only to supply versus the capability here in the east.

And I am, certainly the availability issue is a non-issue going forward

Lastly on the pricing side, Steve put up a graph and showed that service levels across the commodity types are improving sharply.

Is that translating into improved pricing environment for you as you go out and bid new business?

Especially on the intermodal side pricing between rail intermodal and truck has widened significantly, especially if you include surcharges.

Is there an opportunity to get more aggressively while improving pricing on intermodal traffic

Taking the latter question first, we will certainly find out during the busy season.

That's where we have more leverage.

I think we publicly case, publicized it.

September 1 we normally put in seasonal pricing.

The reliable service is certainly giving us more opportunity not only literal conversions from the highway but also entertaining truck load carriers as potential customers or increasing the business.

So we're seeing a lot of that.

You see our strategy.

We are making no secret of it.

We are getting service better.

We think that makes our value better.

Yeah?

Both of you.

Just Hank if you can volume up on the tax rate issues, is that sustainable at these lower levels?

Second quarter in the row we have seen the benefits from lower taxes.

Is that going to stay at this level?

I think that somebody asked that question at the last meeting.

Bill Galanko said somewhere in the range of, or a little over 32%.

We will stick with the 32 number for now.

That's why Bill is here.

You can get him over in the corner.

Actually, Bill is giving me the thumbs up sign, maybe a little higher.

Bill, why don't you follow up with that?

Yeah, the adjustment that caused the rate to be as low as it has been for the first two imaret, quarters will continue to provide benefit for the rest of the year.

There are a number of other factors that set the effective rate and, you know, there is impossible to predict quarter to quarter.

It includes the Conrail equity income and the overall income and ar, various things.

This quarter it happened that they lined up causing the rate to be a little lower than I would have expected.

I would expect the rates to be modestly higher for the rest of the year.

Ike, you talked about some of the preshiping, making some of the intermodal comps a little tougher year-over-year and obviously still out perform that.

Are there lingering impacts from that?

Obviously going into the contract ending in July, but the lock out didn't happen until September, when did you see the preshiping end?

The preshiping ended in August of last year.

So what we will have going forward is perhaps, a tougher comparison or or similar comparison that we have had in May and June into August.

But after that, we are going to see a traditional busy season in September and October that we did not see last year.

So that is somewhat of a switch.

Then I want to have a last follow-up for Steve if I can.

On velocity, you talked about peaking or at least matching where we are a year ago.

Are there lingering impacts from the first quarter or can we see velocity pick up again.

How do you measure on time?

Is that when it reaches the customer, the yard or what?

The on time numbers that I referred to are destination on time, not customer numbers.

We are migrating to a dock to dock performance measurement system, that maybe at some juncture, it might be appropriate to speak to the systems we have in place.

I know we use a number of different acronyms and maybe more fully explain them.

The measurements you saw today-- the premium intermodal on time-- is measured as within one hour of schedule.

For the other measurements, it's within two hours of schedule.

Velocity (inaudible)?

Velocity, our goal in velocity is a theoretical maximum based on what we have done operationally and the fact that we are in reality providing service that really does meet our customers’ requirements and needs.

We find ourselves operating, in an operating configuration that adds a little more frequency to the service and that is driving the potential for the up side of that velocity.

I think that number will certainly stabilize, if not increase as we go forward.

And there is a function of velocity associated or volume associated with this.

I might add that we experienced almost a little over 1% increase in carloads.

And holdover from the first quarter, you see that in looking at first half numbers.

Yeah, there's some degradation because of the experience of weather and a couple accidents that we had.

I would expect that not to be relevant in the third quarter comparisons to second at all

We have had an extraordinarily difficult, my view, or Steve and I have been doing this for a long time.

It seemed to me that so far this year we have had some extraordinarily difficult weather related conditions.

In spite of that we have been able to post improvements in the train performance, which I think our people deserve a lot of credit for.

We are frankly proud of that kind of performance in difficult conditions.

Yes?

Hi.

Tom Wadewitz from Bear Stearns.

Two questions for you.

David, for you, the network is clearly running well in the second quarter, but there is still pretty significant cost side pressures.

You said that you had planned for higher volumes and better economy.

At a certain point do you revisit the head count issue and say we can do more in terms of the head count reduction program?

Because that's really, comp and benefit is such a big line item on the expenses.

Can you give us a sense if volumes are soft, do you revisit that (inaudible) in the second half?

Do you see opportunity to really do something meaningful?

Two points.

Yeah, in my initial remarks I was intending to address that, because we are in fact addressing that issue.

But at the same time as you well know, we continually address the head count issue and we have done that--I think 08% year on year.

So we have made a reduction.

But clearly, at the same time, on the train performance side, we clearly wanted to make sure that we do not run short of train and engine crews.

Because we believe in the economy, we instituted our training program so that we were very certain not to get behind the curve on that.

We think we are not behind the curve on that.

We think that's a solid investment.

Because the economy is going to pick up and what I'm conveying in our continuing commitment to service is that we are not going to back away from being able and ready to prepare that service.

Having said that, we understand that compensation and benefits is a constant challenge.

That's why we have begun the activity value added analysis, which is yet another way of approaching the head count issue.

We are doing that in a, an aggressive and I think even more accelerated manner.

And that will produce improvements and we just want to be careful that we do that without affecting our service.

But we think we have plenty of potential to do it.

I don't want to give you a target number on that, because we have some internal goals.

I resist giving you a target number on that.

You will clearly see us continue to make the traditional progress that we have made over time in that area.

You can be assured it's on our mind.

Okay, great.

One question for Ike.

Can you review with us overall sensitivity of the portfolio business to automotive?

I know if you look at straight auto, auto parts it's something like 15% of total revenue.

But if you look at the secondary effects in metals, chemicals, can you give us any kind of broad car, categorization of how much is sensitive to autos?

And then, from a historical perspective what tends to happen going into a UAW negotiation?

Do we see an artificial spike in August?

Or can you give us a, directional sense on what will happen on with, with that?

You've drawn me into the UAW question, that's a difficult one to answer.

And you know, you would have to know how to, how the negotiations are going to know how that production is lined up.

As I said in my prepared comments, we are heavily related to automotive production, as is U.S. manufacturing.

And 40% of triple crown plus our largest merchandise sector that we call automotive.

And obviously our large steel franchise is related to it--AK steel, U.S. steel, as well as the international steel group, all make metals for the auto industry.

I could even include our six or seventh largest customer, who is Arselor, the largest French steel maker who also provides steel for auto making.

So it, the string is long and complex as to how closely we are related to the automotive industry.

It certainly is more than the $900 and some million that we report in our automotive segment reporting.

You need to add 40% of triple crown in.

We would have, you know, a good portion of the metals business.

Again I would add, Tom, so is U.S. manufacturing--closely tied to automotive.

And we do, as I have been told by some of the auto folks, you guys speaking of the rail industry, are only limited to, by your imagination about the opportunities that we can, that we have out there from converting the business from highway over to rail.

I think we are making inroads there.

We think that we are very pleased with the improving position that we have in automobiles, but also in the whole consumer goods segment.

That's something that we worked hard to develop.

And clearly you see a strategy on our part of trying to develop that and seize upon it as real growth opportunities.

We also understand that that requires us to be very nimble and flexible because they are responsive to demand.

So we are, what we are working hard on is to make sure that we have all of our systems so that it can respond quickly to changes on either way.

Because we do know that things happen in the automobile industry and in the consumer goods industry.

You've got to be prepared to adapt to them and, to keep your bottom line in good shape.

That's our, that's the strategy that we are clearly focused on right now.

Yes?

I have trouble seeing beyond the third row, but --

Tony (ph).

I've got one for Ike and one for Hank quick.

Ike, you talked anecdotally about truck conversions and market share pick up.

Do you total these numbers?

Do you have a net highway conversion for the quarter in terms of, you know, trucks?

Truck loads or rail units or revenues?

I do have one for merchandise.

I think the addition of my numbers that I gave out specifically, it adds up to a little bit more than $20 million.

Coal is, difficult.

We could include the 5 million-tons of conversion from Powhatten Point that was from truck to rail.

That is not happening as frequently as you would see in the other sector.

The number I do not have, Tony, is intermodal which is a big number.

I can get that for you.

Thanks.

I guess the next one is for Hank.

Can you give some color--you talked about the safety stuff.

There's sort of three things appear to be going on.

What we are concerned about, obviously, is the C&I numbers are going up.

The Harrriman was one for the umpteenth year in a row.

And the ratios are going down, , although they are not at the 1997 level--that was a particularly good year.

What is going on in the whole thing?

Is it really just the legal expenses that are climbing at higher rates?

Why is that C&I number going up when you guys continually lead the industry in safety?

There are several things going on, Tony.

You are right on when you say several things are going on.

First of all, we had higher insurance rates for both property and casualty insurance.

Secondly, we had some claims development in the most recent quarter, which reflects a number of things that include crossing accidents.

It includes FELA claims, probably some development with respect to the asbestos claims, all of which are bundled up into an actuarial analysis and the most recent actuarial analysis reflected that development and we are accruing for it.

In the first quarter we had C&I included.

The expenses of derailment, damage to equipment, damage to lading (ph).

So from quarter to quarter it's kind of shifting.

The thing that is of some concern to us is that over the past 12 months we've seen a pop up.

That has management's attention right now.

We are going to act and respond to what we are seeing there in an effort to get a good grip on those expenses.

We noticed as you did, Tony, that that number declined for a number of years, as our safety record improved.

And we don't, we certainly don't want to lose the benefits of that.

Clearly, in reducing the number of cases you achieve benefits from that.

We are attacking it from every angle now.

There are a number of pieces of that and that's another area of concern that we are focusing on.

Hi.

Gary Yablon, First Boston.

Ike, if I could start with you.

In terms of yields overall, could you give us your sense on how you would parse out rate versus 96, mix and what not?

As I looked through it I wasn't sure how that all ended up?

Then, in conjunction with that surcharge, I hate to ask you, but I'm guessing it went your way a little bit.

Can you tell us a little bit about how that played out?

Ike, I'm glad he asked you those questions.

I'm going to ask Hank the same question.

There were, there are obviously three components to the increases in revenue per car.

I'm trying to recall.

I think over one-third, Gary, was attributable to the fuel surcharge.

And then it varies as to which was mix.

For instance, most of the ag revenue increase was mixed with the longer haul.

The decline of the metals was totally mix.

Otherwise, we are getting price increases.

There are price increases throughout all the groups.

When the contracts come up.

And we have been successful with the fuel surcharge.

Not only billing, but collecting.

And, it's in place.

And the way ours works it should be in place for most of the third quarter.

Percent of your customers that are on that program?

I'm not sure. 50%, I would say.

It varies, but some of okr larger customers are on there.

Most of intermodal is included.

Okay, thank you.

Just a couple for Hank if I could.

Hank or Bill, we bill a tax rate for this year.

What about for next year, ballpark?

I mean, low 30s or upper 30s?

Gary, if you save that question until the first -- the first meeting next year, we'll have a better answer for you.

I haven't even seen a budget for next year yet.

Okay.

Staying with you, Hank if I could.

The labor stuff, the head winds you have are things that are hard to change.

Pension can move around, but salaries, wages, health and welfare of some real head behind, head winds.

How should we think about that?

Should we think about the experience you saw in Q2 this quarter in terms of labor cost increase as being -- it's the norm until it isn't, ie. addressing head count and what not?

How should we think about that?

With respect to wage increases, those wage increases were a product of the most recent contracts that have been negotiated.

And I guess some are still in the negotiating stage.

Obviously, the health and welfare costs have been going up at a fairly dramatic rate.

I believe that in the new contracts there will be some cost sharing that will be forthcoming from those contracts.

And that should be of some help on a go forward basis.

But quite frankly we have, over the past three years, demonstrated an ability to adjust the size of our work force and increase the productivity of that work force.

And that has largely offset some of these increases we have had in prior years.

On a go forward basis the challenge for this management is to continue to develop those productivity increases.

And to contain the compensation and benefits costs for higher wages, higher salaries, higher benefits by increasing the productivity of the work force.

And we are in the process of doing that.

Do you feel fairly confident that you can continue along the path, maybe the trajectory isn't the same as it has been in past years, but directionally?

The trajectory can't be the same as it was.

Post Conrail merger, we were nearly at 36,000 employees.

And Today, we are slightly over the 28,000 level.

I think one point that David was trying to make a few minutes ago, it may be getting lost.

That is, that we increased the number of T&E employees--trainees and new employees by nearly 160 employees, compared to a year ago, in anticipation of increased volumes and increased business.

And if we are going to continue to provide the kinds of improving service that we are providing to our customers, we are going to have to have those people to do the job.

And I think that that kind of improved service is going to be the basis on which we can build not only the volume of business, but justify the increases that we need to get from the customers in order to earn our cost of capital.

Thank you.

You know, Gary, I'll just say I can't improve on the way Hank has said that.

You did get on your soap box there a little bit, Hank.

Good work .

Obviously from the CEO's vantage point on compensation and benefits is a constant challenge because it's such a big element on the cost side.

And so clearly your objective is to offset the inevitable increases--manage those increases as carefully as you can, but offset the inevitable increases but with productivity gains.

We have a very good record of doing that, and we do that by, we do that by improving things like the technology of our system, which runs the Thoroughbred operating plan and gives our people -- as we do in our so-called local operating plan add learns, the LOPA -- that gives our people a lot of power in improving the utilization of the work force out in the field.

That takes effect.

It doesn't necessarily take effect instantly, but it takes effect.

We are seeing it now and you will see it as it goes on because we have made, we made a lot of investments in technology to improve our operating systems.

Not all of those are in place yet.

I mean, they are going on in an incremental basis.

But when you look at those train performance numbers, you are seeing the benefits of a lot of investments over the last several years that have been made.

And when you look at the declining work force, you are seeing the benefits of those investments that have been made as they reflect an increase in productivity.

I think we have both a lot of experience and a lot of knowledge in our system as to how to achieve those improvements.

The quarter shows us that we clearly have a significant challenge in this area because we are up against them, as you say the head winds.

But we certainly have our eye on it.

I'm confident we can manage that.

Two speeches for one question, Gary.

Yes, sir?

Given some of the changes over at Wabash National, what is the long-term picture for triple crown?

Ike, do you want top respond to that?

I'll just say that we have a very strong belief in triple crown as a product.

And as a technology.

And we are certainly talking to the people at Wabash national about that.

And I think that we will certainly find a way to continue a good product, which has a market.

Anything more you want to say on that?

Any other questions?

You have been very patient.

Well, thank you for your attention.

We look forward to seeing you next quarter.