Norfolk Southern Corp (NSC) 2004 Q1 法說會逐字稿

As always, let me welcome those who are listening and participating on the Internet today.

And I will remind everybody here to use the microphones so that our listeners can hear.

Let me quickly begin by introducing the Norfolk Southern folks who are here.

We have Hank Wolf, Chief Financial Officer, and Steve Tobias, our Chief Operating Officer.

Ike Prillaman, our Chief Marketing Officer is unable to be here today.

He's off traveling, and hopefully securing some new business but he's ably represented by Don Seale, our Senior Vice President of Marketing Services is here with us today to talk about the marketing side.

Also with us today, we have Jim Hixon, and our Chief Legal Officer over there, Kathryn McQuade, Senior Vice President of Finance, Bob Fort, our Vice President of Public Relations is here, Marta Stewart, our Vice President and Controller is here to talk about the numbers, and Leanne McGruder, Director of Investor Relations who I hope everyone knows and Debbie Malvin [ph] Hank's assistant, I think is outside the room at the moment-no, she's in the back here, Debbie Malvin [ph], Hank's assistant is here.

So everybody's here to be of assistance and answer your questions, I hope you'll use them.

When we last gathered in January, I was pretty optimistic and I said that the stage was set for continued strong performance as we headed in to the year.

Now I'm naturally very pleased to report the quarter in which Norfolk Southern has set a number of financial and operational records, which I'll mention before Hank Wolf gets specific.

First, we recorded the highest railway operating revenues in our history.

Second, we posted our best ever income from railway operations.

Third, we produced the lowest first quarter operating ratio since the Conrail integration in what is traditionally the most challenging quarter of the winter.

And that number starts with a seven, those of you who follow us regularly know how important that is to me personally, and to all of us.

Fourth, our network velocity based on average train speed reached an all-time high, and was among the best in the industry.

Fifth, we improved our terminal dwell time over earlier levels.

And finally, our network fluidity continued to improve in this quarter as we handled approximately 109,000 more car loads while our cars online remained stable throughout the quarter.

The short story is we had strong business demand, and our Norfolk Southern people stepped up to handle it with good service.

But, we should say also that this record performance in a quarter of strong car loadings and revenues was also made possible by the physical capacity of our network, which as you know was built through continuous investment as we've been telling you about over the last several years, the strength and flexibility of our Thoroughbred Operating Plan, which demonstrated this quarter that it can adapt to changing conditions and shifting business.

The third factor that I would mention is that we made early investment in hiring additional train and engine crews, and we also consistently and reliably executed our operating plan.

But unquestionably, the most important factor in the first quarter for us was the outstanding performance of our safe and dedicated workforce to pull all these things together.

Now, superior operating performance fuels network efficiency and productivity improvements.

It also enables us to attract more business and pursue pricing initiatives.

As you look at the numbers, you'll see that strength is very broad based, and most important, the good results are very much from our basic business.

I'll give you one more statistic.

In the first quarter, we were able to handle a seven percent increase in car loading with just 3.7 percent additional train starts.

That's good leverage for those of you who follow the business, as you'll know.

And our service quality helped us support an 8% increase in revenues in the first quarter.

The results you see today reflect our rigorous focus on continuous improvement and service, while at the same time we maintain our concentration on improving an already award-winning safety record.

Now, a few highlights before I turn it to Hank.

Net income in the first quarter, as you'll see, is $158m or $0.40 a share, and that compares with $85m or $0.22 per share reported last year, and last year, as you will remember, was before the cumulative effect of required changes in accounting and discontinued operations, which we had in the first quarter last year.

Including those items, total net income in the first quarter of '03 was $0.54 per share.

The first quarter revenues increased $132m or 8% year-over-year, and our expenses were up only $17m or 1%.

As a result of that good equation, income from railway operations set a new record at $346m.

That was up $115m, or an increase of 50% in the first quarter of '04 compared with the same period last year.

We achieved record results the old fashioned way, they were through the strength in income from our railway operations.

Norfolk Southern's exceptional first quarter performance is a solid platform for the remainder of the year.

While we continue to push conversions from the highway, high fuel costs, and highway congestion, and other factors are helping us do that.

The strength in the first quarter was pervasive across the board.

Intermodal was up 13% and set a quarterly record.

Total revenues increased 12% in the first quarter, and general merchandise revenues were up 5%.

These trends are continuing.

Don Seale will provide you with the details on our revenues on all fronts in a few minutes.

As you know, cost control is an area of intense focus for us, and our initiatives are producing headway.

Railway operating expenses, which were up 1% as I said earlier on 8% higher revenues is an example that this produced an operating ratio of 79.6% in the first quarter of '04 compared with 85.2% in the same period last year.

Now this is our best operating ratio since the integration of Conrail, and I'm even more pleased that it was achieved in the first quarter, which as all of you know, is traditionally the most challenging for railroads.

We have more work to do to reach our goal of achieving an operating ratio that begins with a seven for the full year.

We are, however, moving in the right direction, and cost containment and margin improvement remain at the forefront of all of our efforts at Norfolk Southern.

Looking ahead, I remain optimistic about the health of the industrial economy.

For April so far, our overall car loadings are up approximately five percent, lead again by Intermodal, which is up 12% year-over-year.

We're seeing increased demand for consumer products, and traffic growth from new truck competitive services.

We're beginning to see demand develop in the wake of trucking issues, such as hours of service, rising fuel costs, and of course importantly, the highway congestion, which is pervasive.

We're pushing volume growth and profitability hard, and our efforts are paying off.

We expect coal volumes to continue strong as we head in to warmer months.

In addition to utility strength, we're seeing improvement in the export coal markets, which continues to benefit as a result of the relative weakness of the dollar, higher ocean-going rates, and the impact of China on the market.

As we move forward, we will not waver from our commitment to pricing that reflects the current market value of our rail service, particularly in today's market.

Our strong and improving service gives us an advantage and an increasingly valuable product going forward.

I've been waiting for our people to have the opportunity to test our new operating plan and our new operating philosophy against strong business volumes and severe winter conditions.

We gave it an opportunity to show productivity increases before the volumes came back.

But now I'm pleased to test it in a time with strong business volumes, particularly in the first quarter when winter conditions always make it difficult.

The first quarter provided that good opportunity for testing, and I think Norfolk Southern passed with flying colors.

TOP, our Thoroughbred Operating Plan, enables us to produce performance metrics that continue to improve, even as our volumes strengthen.

We believe we can continue productivity improvements in that environment, as the economy and freight volumes continue to gain momentum.

We have the capability to add business profitably in our system.

At some juncture, we may reach a point where we'll need to add additional train starts to handle the increased volumes.

I hope we do.

And that can initially put some pressure on the operating ratio.

Moreover, as business volumes increase, we may need additional system capacity to meet business demands.

Again, I hope we do.

However, importantly, we are not there yet.

In fact, all indications point to the fact that our network can continue to adapt and handle increased volumes without a significant increase in capital spending.

We're staying the course.

Going forward, I have every confidence that Norfolk Southern will continue to successfully forge ahead, improving service, and pursuing new business and margin improvements as we do, reaffirming our position as the thoroughbred of transportation.

Now let me ask Hank to review our numbers in detail with you for the first quarter, and then Don will be right behind him to talk about the specifics of the market, and then we'll all be happy to field any questions you have.

Hank?

Thank you David, and good morning.

As David indicated, we're delighted with our first quarter results.

As you'll see, a significant gain in our railway operating revenues, coupled with a modest increase in operating expenses allowed us to produce record income from railway operations.

As you'll recall, our first quarter results last year included $114m or $0.29 per share after tax benefit from the cumulative effects of two changes in accounting principles, and a $10m or $0.03 per share after tax gain from discontinued operations which related to our 1998 sales of North American Vanlines.

In order to provide you with the most meaningful comparisons to last year, I will initially exclude those items from my remarks this morning, and then reconcile the totals with our reported results in 2003.

Railway operating revenues for the first quarter reached a record $1.69b.

Our revenues were up $132m or 8%, as merchandise revenues increased $49m or 5%.

Coal revenues rose $44m or 12% and Intermodal revenues climbed $39m or 13%.

The increase in our coal revenues, includes accruals for coal shipments in Duke Power and CP&L destinations at the rates determined to be reasonable in the rate case decisions announced by the STB.

I would remind you that those decisions may change in response to motions for reconsideration filed with the Board.

I want to emphasize that our coal revenues in the first quarter include not only the rate increases determined to be reasonable in those cases, but also other rate increases and mix changes as well.

I would add that in the absence of adjustments applicable to prior periods, first quarter coal revenues reflect a representative quarter from the rate standpoint, recognizing that we have contracts coming up for renewal regularly, and periodically experience changes in mix.

Total car loads in the first quarter increased almost 109,000 units or 6.6% compared with last year, lead by increased Intermodal volume.

However, I should emphasize that every commodity group posted an increase in volume in the first quarter.

In addition, revenue per unit increased by 1.8%, which when combined with the 6.6% increase in volume, resulted in an 8.4% increase in our railway operating revenues.

And Don Seale will provide you with the details of our revenues in just a moment.

Railway operating expenses for the first quarter were $1.35b, an increase of $17m or 1% compared with last year.

As you can see, the increase in railway operating expenses was primarily the result of higher compensation and benefits expense, which were up $19m as the pluses and minuses in most of the other categories were largely offsetting.

The increase in compensation and benefits was driven by higher wages, which added $12m, $3m less in pension income, and $2m of increased costs for health and welfare benefits.

Other miscellaneous items added $2m.

Material services and rent expenses produced the next highest increase, rising $5m or 1%.

Higher total volume related Intermodal purchased services and an increase in locomotive and freight car maintenance expenses were offset in part by lower equipment rents.

It's noteworthy that even with the increased volumes that we handled in the first quarter, our cars online remained constant or level reflecting the fluidity and efficiency of our operations.

Other expenses rose $4m, principally due to higher property taxes and sales and use taxes.

Diesel fuel expense increased $3m or 3% as consumption rose by 6% from 121 million gallons last year to 129 million gallons this year.

But this was partially offset by a 3% decrease in the average price per gallon.

The average price per gallon declined from $0.86 per gallon in the first quarter of '03 to $0.83 this year.

We continue to try and hedge approximately 80% of our projected fuel requirements.

In the first quarter, we hedged approximately 76% of our diesel fuel requirements.

Second, third, and fourth quarters are 76%, 67%, and 58% hedged respectively.

During the first quarter, we hedged a little over 97 million gallons of fuel at an average price of $0.81 per gallon.

We have approximately 92, 79, and 70 million gallons hedged in the second, third, and fourth quarters respectively.

The average price per gallon on these hedges ranges from $0.78 in the second quarter to $0.82 in the fourth quarter.

Depreciation expense was up $2m in the first quarter, reflecting our continued investment in plant and equipment.

There were two favorable changes in railway operating expenses during the first quarter.

Casualties and other claims expenses decreased by $11m.

As you'll recall, the first quarter of last year was burdened with some high derailment costs, and an increase in our accruals for personal injury claims developments.

Also, Conrail rents and services declined by $5m, largely due to lower shared asset area costs.

The 8.4% increase in operating revenues, coupled with the modest decrease in operating, excuse me, the increase in operating expenses produced a first quarter railway operating ratio of 79.6% compared with 85.2% last year.

This is our lowest quarterly operating ratio since the integration of Conrail in 1999.

Income from railway operations for the first quarter was a record $346m, which was $115m or 50% above the first quarter of 2003.

Total other income and expense for the quarter was an expense of $111m compared with an expense of $106m last year.

Gain on sales of property and investments was $1m compared to $5m last year, a decrease of $4m.

Coal royalties were flat year-over-year at $9m.

All Other netted to zero in the first quarter compared with income of $7m last year, which, as you may recall, benefited from reductions and efficiency interests attributable to favorable income tax adjustments.

And finally, interest expense on debt was $121m, $6m or five% lower than last year due to less outstanding debt.

First quarter income before income taxes was $235m compared with last year's $125m, an increase of 88%.

The provision for income taxes for the first quarter was $77mdollars compared to $40m last year.

The effective tax rate was 32.8% compared with 32% in '03.

The effective tax rate for '04 is below the statutory rate due to the equity earnings of Conrail, which were reported on an after tax basis, and the benefit of certain tax credits available, primarily under Section 29 of the Internal Revenue Code.

Based on Section 29 tax credit investments that we have in place today, we expect our effective tax rate to be approximately 33% for the year.

However, we continue to seek opportunities to make investments and additional tax credits investments, and those investments are made from time to time.

First quarter net income was $158m, an increase of $73m or 86% over the $85m dollars earned in the first quarter of '03.

This chart summarizes the changes in our first quarter results this year compared with last year.

Railway operating revenues increased $132m, while railway operating expenses increased $17m.

Other income net declined by $11m.

And interest expense on debt was $6m less.

Income taxes increased by $37m, resulting in a $73m increase in income from continuing operations.

Earnings per share for the first quarter were $0.40, an increase of $0.18 or 82% over the $0.22 per share earned last year.

This slide reconciles net income and earnings per share for the first quarter of '03, excluding the effect of the accounting changes and income from discontinued operations to our reported net income in the first quarter of '03 of $209m in earnings per share of $0.54, which included those items.

So again, our reported net income for the first quarter of '03 was $209m or $0.54 per share compared with the $158m or $0.40 per share in the first quarter of '04.

Thank you for your attention, and I'll now turn the program over to Don Seale who will give you an in-depth report on our revenues for the first quarter.

Don?

Thank you Hank, and good morning.

It's good to be with everyone again.

As you've heard already this morning, we were very pleased and quite encouraged by our first quarter results as we saw solid increases in all three of our primary business sectors.

Certainly signs of a sustainable economic recovery emerged during the quarter, and we were able to fully capitalize on those positive trends.

Our industrial carload business responded favorably.

The gains in manufacturing, as you know, we watched the institute of supply chain management index closely, and that index remained above 60 for the fifth consecutive month, suggesting expansion in all aspects of manufacturing.

Now while consumer debt remained high, lower interest rates continue to encourage spending.

This metric is obviously favorable for our automotive business, and has supported significant gains in our Intermodal traffic as well.

Inventories are reported to be low, including utility stockpiles, and a weaker dollar and the current impact of global demand on raw materials drove gains in our export markets.

And just as important as the economy, our transportation network remained fluid, producing strong metrics during the quarter, which kept us on track in the pursuit of our stated objectives of gaining business from the highway, and realizing higher value for our transportation services.

With positive manufacturing and retail growth, we saw first quarter volumes continue to move upwards.

These positive trends, coupled with our Thoroughbred Operating Plan, produced record volume in the first quarter of 1,757,000 loads, an increase of 109,000 units or 7% over last year.

There was strong year-over-year comparisons throughout the quarter, and March produced our highest volume month ever.

Volume gains were lead by double-digit increases for Intermodal, and metals and construction.

Our coal volume with 406,000 carloads increased by 11,000 units over last year due to improved utility and industrial coal volumes.

Intermodal volume was 648,000 units was propelled by truck load and domestic volume growth, and merchandise, our industrial sector, reached 703,000 car loads, with gains in all five markets.

Now with higher volume and improved yields, we achieved our highest revenue quarter as well, nearing $1.7b in railway revenues.

March was our highest revenue month ever.

After setting a new revenue record in the fourth quarter, our merchandise sector reached its highest quarter ever at $967m, increasing $49m or five percent over the previous year.

Each of our merchandise groups produced gains ranging from 3%-10%.

Coal achieved its highest revenue quarter, producing $398m, an increase of $44m or 12% over last year.

Longer haul volume, spot shipments, and improved yields drove this performance.

And following the record fourth quarter last year, Intermodal achieved its second highest revenue quarter at 328 million dollars, an increase of $39m or 13% over the same period last year as we enjoyed increased volume and improved yield.

Turning to revenue per unit, revenue per unit for the first quarter 2004 set a new record, reaching $964 as the result of improved pricing and traffic mix, which included longer haul volumes.

Merchandise achieved its highest revenue per unit ever, reaching $1,377, a gain of $17 or one percent.

Paper and forest products had the highest revenue per unit gains and its highest quarter ever.

Revenue per unit increased $55 or 4%, primarily as the result again of rate increases and favorable mix.

Metals and construction reaches its highest quarter, improving six dollars or one percent over last year, despite a substantial increase in shorter haul aggregates trapping during the quarter.

In the steel sector, the recovering domestic steel market helped drive gains of longer hauls, higher rated iron and steel shipments.

In the automotive market, automotive yield continued to improve, increasing by $33 per unit or 2%, primarily from new auto parts business and vehicle traffic, along with enhanced pricing.

Revenue per unit for coal increased to $979 for the quarter, up $84 or 9%.

This increase was due to several factors, which include longer haul spot coal, the Service Transportation Board's decision in our two rate case proceedings, higher tons per car, and the positive effect of recently renegotiated utility coal contracts.

With respect to the two rate cases, for the quarter, we applied the rates in accordance with the STB decisions.

However, as you know, these cases remain open for the Service Transportation Board, and motions are pending in both cases.

And finally, our Intermodal revenue per unit increased to $506, rising $6 per unit, or 1% on a 28% gain and higher rated trailer volume driving the improvement.

Our Intermodal services experienced very strong demand in the first quarter as volume increased by nearly 70,000 units or 12 percent over last year.

We surpassed internal expectations in all of our lines of business.

Surging domestic volumes, consisting of asset-based truckload carriers and Intermodal marketing companies helped drive this improvement.

These two sectors increased by 22% and 24% respectively.

Our domestic customer base is clearly converting freight from highway to rail, and it's based on consistent service, higher truck prices, and we think the early impact of the new hours of service laws.

Our domestic growth is also being fuelled by our Thoroughbred Direct, our TDIS subsidiary, which is gaining substantial traction as a door-to-door logistics provider for our domestic customers who are seeking to convert freight from the highway.

Triple Crown's eight percent gain over last year is due to continued strength with core automotive and consumer products customers.

Our premium business increased principally due to the resurgence in less than truck load companies bringing freight back to rail.

During the first quarter, I'm pleased to report we also achieved a significant service milestone by providing United Parcel Service, UPS, failure-free service for 200 consecutive days as of this morning.

That's a record among the big four class one carriers.

International volume, our largest Intermodal line of business, grew by 18,000 units or seven percent, reflecting the strength of US foreign trade and our strong relationships with the ocean carriers.

In addition, with the home dock access to the east, east coast ports that we enjoy, we continue to benefit from the trend of all water routing from Pacific Freight to the east coast.

Overall, in the quarter, consistent service performance and focused marketing efforts resulted in the successful conversion of approximately 44,000 Intermodal loads from the highway during the first quarter.

This performance equates to half of Intermodal's total 2003 conversions.

For the remainder of the year, we anticipate continued results along the lines of those experienced in the first quarter, certainly assuming the retail and manufacturing sectors continue to expand.

We also expect the pace of highway to rail conversions to continue, and we see strong growth in our international business as we're very well positioned from the growth in US trade.

Turning to our coal markets, coal markets, both here and abroad, continue to be dynamic during the first quarter.

Higher demand for steam coal due to cold weather, lower stockpiles, and economic expansion combine to constrain coal supplies to many utilities in our network.

Increased demand for high [vol] metallurgical coal further depleted the supply for utilities.

In addition to the effect of winter and increased electrical demand for industry, high natural gas prices drove intermediate load coal fired units to operate above normal capacities in the quarter.

Despite the challenges of coal supply, our first quarter volume rose to 406,000 loads, increasing 11,000 units or three percent over last year.

Within the market segments, utility volume increased by 3% or 9,500 loads as several contracts were successfully renegotiated with higher volumes.

Industrial coal experienced the largest percentage increase, rising 3,100 carloads or six percent.

Economic recovery and new business drove this improvement.

Our export volume increased by 830 carloads or 3%, while met shipments, metallurgical shipments, increased by 2,100 carloads or 8%.

Our export markets experienced similar supply problems, and high and low [vol] metallurgical coal continues to be in tight supply.

Global demand is strong, and the continuing outage of the former US steel mine at Pinnacle Creek, which is a major producer of low [vol] coal, cut the supply from the first quarter.

We are optimistic that production at this major mine will resume in the third quarter with a run rate of four million tons annually.

We expect demand for US coal in the export market to continue to be strong.

Global supply shortages can be attributed to several factors, ranging from the withdrawal of Chinese metallurgical coal from the export market to record ocean freight rates and a weaker dollar.

And finally with respect to our domestic met coal markets, both coal, coke and iron ore experienced declines versus first quarter 2003 as shortages in raw materials led to reduced availability.

Supply of domestic met coal is currently not available to meet total demand for coke production.

We don't expect this to improve in the short run as the market for Chinese coke remains very tight.

Looking ahead, prospects for utility coal remain very encouraging.

Stockpiles are below target, we believe due to the cold winter, and utilities are certainly expected to rebuild the inventories this quarter for the summer months.

The Department of Energy recently reduced its estimate of December stockpiles by $15m tons from year-end inventory levels, which certainly suggests higher coal demand for the balance of this year.

In addition to reduced stockpiles, the high prevailing price of natural gas should continue to favor from coal fire generation as the lowest cost source for electrical generation.

With this increased demand we see, and we hope this is correct, we see improving coal supply ahead as northern and central Appalachian mines work to increase production.

Also, Powder River Basin coal conversions will continue to bolster supply in the east.

Looking at our remaining markets demand for export and domestic metallurgical coal will remain strong with improving coal supplies to the Pinnacle Creek mine reopens net coal volume and coke shipments should improve.

Now turning to our merchandise markets, we had a strong quarter in our industrial markets.

Revenues reached $967m, which was a new quarterly record.

Total revenue increased by 5%, volume improved 4%, which was driven by a 10% growth in metals and construction, a 5% boost in volume in agriculture, and a 4% improvement in chemical loads.

Chemicals revenue of $203m was its highest ever, driven by increases across all of our chemical segments.

Strong demand for petroleum related products such as asphalt and propane lead these increases.

Looking ahead, our major concern for chemicals is the continued high price of natural gas feed stocks.

Metals and construction revenue in volume both improved ten percent over the previous quarter last year.

Iron and steel revenue increased by 19%, accompanied by a 14% improvement in volume.

This market benefited as a weaker dollar resulted in lower imports and higher domestic steel production and shipments.

And during the quarter, we saw growth in steel shipments from nearly all NS served mills, and we handled record scrap steel volume, which was up 19%.

In the construction materials sector, strong demand from projects boosted volume, lead by a 37% increase in crushed stone, along with higher volumes in gypsum, brick, industrial sand, and limestone.

Our agriculture revenue of $176m, increased $8m or 5%, while volume was up 5% over the previous quarter.

Ethanol has been a significant driver in agriculture's year-over-year gain, with sweeteners and ethanol revenue increasing 18% over last year.

Also fertilizer revenue was up 13%, driven by increased demand.

Paper and forest products revenue reached $157m for the quarter, increasing $7m or 5% with a 1% increase in car loads.

This was paper's 7th consecutive quarter for year-over-year growth.

Our multi-modal paper distribution service, Thoroughbred Extra, helped drive overall results, which included a $4.5m gain in annualized highway conversions in the first quarter.

Finally, our automotive volume for the quarter remained flat in the face of flat North American vehicle production.

Automotive revenues, however, increased by $6m or 3%, primarily due to favorable traffic mix and yield improvement.

After seeing very sluggish volumes in January, automotive revenues for March reached a new record as production of Ford's new F-150 model pick-up truck generated a 10% gain in revenue from auto parts to the north of Kansas City assembly plants.

Also during the first quarter, Honda's new Lincoln Alabama assembly plant shifted full first plant volumes, and the second plant is now scheduled to begin production in the second quarter.

These two new plants will produce a combined volume of 300,000 vehicles per year at full production.

In addition, Ford will begin national distribution of its Freestyle and Ford 500 models at its re-tooled Chicago assembly plant by mid year.

As we look ahead, we're optimistic that our automotive business will continue to improve over the course of the year as we target parts diversions from the highway, and new production continues to ramp up.

To recap and summarize our markets, we're very pleased, obviously, with our first quarter results, and also with the outlook going forward.

All three of our core markets are seeing very positive economic trends.

The manufacturing and retail sectors are improving, inventories and stockpiles are being rebuilt, and the current global economy favors US exports in coal.

It's also notable that even with higher volumes over the past three quarters, we continue to have substantial network capacity to handle additional growth.

Looking at our April car loadings to date, the solid momentum from the first quarter continues, and we're excited about our prospects in the months ahead.

As economic expansion builds, we're very well positioned to enjoy further growth in all of our markets, and higher value from our services.

Thank you for your attention, and look forward to your questions.

Thank you Don.

Any questions?

Yes.

Hi.

Greg Burns, J.P. Morgan.

I'm wondering for your question on the network having additional capacity before you have to ramp up CAPEX, can you quantify that either in what kind of growth you can sustain in car loads where you really have to ramp up, is it 5%, 10%?

And then secondly, on the comments on coal, I just want to clarify you, someone seemed to indicate that the price of coal or the yields were representative, even though new contracts are coming up.

Shouldn't we assume that as contracts are coming up this year that coal yields will improve as they get re-priced.

Can you talk on those two points?

Yes.

The first question is I, I think I would, I think I would prefer not to give you a percentage number on the capacity because what we're seeing is that we're, we are discovering the capacity in our system.

We made investments, not only in the physical properties, although we did that over the last 5 years in our system to increase capacity as we increased our geographic size of our network.

We also made a lot of investments in systems and in technology and in the operating systems that we use to run our network.

The real, the best way to increase capacity is to increase the productivity and efficiency in the system.

We, what we're seeing in this quarter is that the way we have done that, the philosophy of our operations and the technology that we've put in clearly has given us the capacity to absorb the increased volumes that we saw in this quarter without adding a lot of physical capacity.

We expect that, we expect to be able to continue to do that as we test how far our new technology and productivity can push our systems.

And we think that we have the ability to do that, that's not to say that we won't make targeted investments as we go along, and we're every day making additional investments in the information technology to run the system better.

But we believe that we're very much open for business in an expanding economy, and we're looking forward to the opportunity as we go along to continue to push that capacity.

So I don't know what the top limit is but we're going to find out, I hope, I hope to have the opportunity to find out.

And on coal-

On coal, let me ask Don to, or Hank, I'll let either of you volunteers respond to that question.

Don, why don't you-

Well, certainly on coal pricing, we take in to account all the competitive factors that are out there, and the alternatives, and that's part of our pricing equation, we are pricing to market.

And we do see opportunities for improvement in the market.

And I think that's a fair assumption going forward, and we will be looking at it that way.

But what we don't go in to it with a pre-set formula, we look at the market, we look at the competition, we look at the alternatives, and there are a lot of alternatives in these markets if we take in to account when we make a decision [and a proposal].

All pricing is-

Adjusting for the mix, right, but adjusting for mix, given your outlook on what you see, it's reasonable to expect apples to apples to apples, coal yields to move up as your book is repriced.

Is that correct?

We certainly are going to be attending that that.

That would certainly be our objective.

All pricing is competitive, and as you well know, we think we have a high value product, we're trying to demonstrate the value of that product, and price accordingly.

That's our philosophy, we've been very open with our customers and with all of you about that.

And our objective is to make our service more consistent, more reliable, and therefore, more valuable to our customers, and achieve, to some extent for our own investors and shareholders, at least some of the benefits of those improvements, and that's the way we price as best we can, yes.

[inaudible] for the past two years where there was a dispute with Duke, or is just booking at that higher rate for the first quarter.

Do you want to do that Hank or Marta either?

I thought that I made that clear in my remarks, but apparently I didn't.

There is no catch-up accruals, this is just the accruals at the rates that were prescribed in the STB cases.

Okay, since you're, you're up there, maybe one more question, one for you and then back to Don.

The expense performance, in particular rents and casualty and other preferred favorable performance, is there anything one-time in there that benefits or is this kind of the run rate going forward, you expect really strong performance in those segments?

I think this is run rate pretty much across the board on the expense side.

There really were no unusual items.

Certainly last year, on the casualty side, we did have the increased derailment cost in the accruals that we had to make with respect to personal injury claim development.

That was a little bit unusual, and I think I've indicated to you that it's not unreasonable to look at a quarterly number somewhere in the low 40's for casualties and other claims, but I would say that it's very representative across the board.

Now, obviously, compensation and benefits, you're going to see some fluctuation with respect to a number of items, including stock based compensation and the number of crews that we have to use in order to handle the business volumes that we are enjoying right now.

Okay, great.

And just-

One more?

Well, one for Don.

In terms of, the environment seems about pretty much ideal in terms of asking for price increases as demand is very strong, you're running the network very well, your competitor isn't running particularly well.

Are you being more aggressive, can you be more aggressive in what you ask for now than what you did last year or the year before on contracts that expire?

Well again, you know, all markets are different, all the markets are not uniform.

So we look at them very specifically with respect to what the competitive alternatives are, we do price to the market.

And certainly the environment today from a trucking perspective is quite good in terms of rail as a solid alternative, and also the value of rail.

So we're really looking at that very closely, looking at that delta between truck pricing and rail pricing, and as our service continues to move up in terms of its overall value, making sure we close that delta to the extent that we can.

So the environment is good.

Let me get Gary here, and then I'll get back to you.

Hey welcome, nice to see you.

Just a couple of questions, and it may be for you, David.

In the export coal market, it used to be a very big market for your company some years ago.

And I'm just trying to understand why you can't start to get back towards that.

I know we're not going to go back to where it was in the very early '90's, but do you have the capacity-

Well, we're certainly, we're certainly working hard to get back to it.

You and I are old enough, Gary, to remember the silent days in that-well, I'm older than you are.

But, I don't, I don't realistically look to get back to the 40 million tons of market today, at least any time, any time soon.

But we did make, as you will recall, a conscious decision and a commitment to stay in that market, even in the worst of times, even when the dollar was, you know, with the dollar-Euro relationships, and the Australian dollar all were just absolutely low, we made a decision that that was a business that we wanted to be in long-term, and that we would, and that we made the commitment to stay in it.

I think that was, in retrospect, the right decision.

We're there, we're available, and clearly, that market is developing.

We see a lot of demand for export coal.

The problem now, frankly, is finding supplies, and we're working on-my experience, my long experience in the coal business is that when the price is right, supplies have a tendency to develop.

And we see some signs that that's happening, so we expect that market to be considerably stronger over all this year than it was last year, and we, our commitment is, again, to make that grow and develop as much as we can because its business is good, it's business in which we think we have a franchise, and we're going to push it.

How far, how high it will go, you know, I just don't know, and you've got to be nimble because the economy changes, and that's the way we're going to work it.

If I could just throw more, two more maybe, maybe quick ones at you.

CAPEX, locomotives, freight cars, the industry, maybe you're the exception, the industry seems very tight, like a rubber band all over North America.

Does this industry, did this company go through a bit of a ramp up in a CAPEX [angle] as it relates to locomotives, maybe freight cars to a lesser degree?

Well, we, you're right, the locomotives are very tight.

That's, again, an area that we hope to address, we expect to address by productivity in our system, which is the best way to get additional car and locomotive capacity is by running an efficient network and getting better utilization out what you have.

We're pressing that as hard as we can because of our commitment to reduce our debt, and therefore, to control our capital expenditures, we've stated our objective to do that as clearly as possible.

We will have enough locomotives to handle the business.

We're going to, we're going to make sure that that's the case, and I have a Chief Operating Officer who is very diligent at making sure that, making sure we do that.

We have, we've announced our investment plans.

Hank, you want to just mention briefly, remind everybody briefly what we have said about our investment plans for the balance of the year, and that's, we're going to stick with that, I think.

We had announced originally a capital spending [inaudible] of $805m.

And I think we've indicated that assuming they're available, that it's very likely that we'll take an advance purchase of locomotives at the end of this year which serves two purposes.

Number one, it provides us with additional units to handle the increased volume that we've seen, but also by taking delivery this year, we are under the existing emissions requirements, and it gives us a little more opportunity to take a look at what the manufacturers are producing in terms of the new emissions-on the new units that will be coming forth in 2005 and beyond.

Being disciplined in capital spending in a growth environment is a challenge.

But we've had lots of challenges before, and this is one that I relish, frankly, this is the right kind.

Do you have another question?

Just, just western connections, if you could talk a little bit about how that's feeling-

Yeah, Steve, you want to comment on that?

I'll get Steve Tobias to talk, because I'm going to ask Debbie to get me a glass of water.

Frankly, we enjoy our western connections.

We would that there were more, but I don't think that's the essence of your question.

There, there's certainly are some implications, particularly in certain segments, not only in the West, but in the East, as it relates to interchange.

We feel very comfortable within our own system that our velocity, our cars online have helped us overcome any impact by anyone else's operating constraints from the standpoint of the customer's perspective and the visibility of that.

My crystal ball doesn't allow me to look into the future much further than anybody else in the room, but to date we're very comfortable with where we are and what we've been able to do within the confines of our own property, vis-à-vis equipment supply and servicing our customer base.

We're working aggressively with all of our interchange connections to do everything that both of us can to make the overall system operations as smooth as possible, and the industry has good history of finding ways to do that and I'm pretty optimistic about it.

Yes ma'am, back of the room.

Good morning.

You guys did make it pretty clear that there was no catch up accrual this quarter for the rate case-the higher rates in the rate case decisions, but if I understood it correctly, you had been creating a reserve on your balance sheet for the portion of the prices that were in dispute.

Does that reserve still exist?

Or has that been sort of released into the income statement yet?

I'll defer to my financial folks.

Jennifer I think that the best that we can do at this time is indicate that what you're looking at is a fairly good run rate in terms of what we're able to generate on revenues from our coal shipments that we're handling.

As far as any accrual reserve, I don't think it'd be appropriate to comment on it at this time because those cases still are subject to motions for reconsideration.

There's still in a state of [pendency] before the STB, and what we are trying to do is to help you all understand what the likely go-forward run rate would be.

Great, that's helpful.

And then, what is the timeframe for a final decision on these cases?

Want to have Jim Hixon respond to that?

Jim?

I'd hate for the chief legal officer to come without having anything to say today.

You aren't going to be able to say anything on this are you?

There is no required timeframe for the board action on motion [inaudible] incineration.

So it could be next week, it could be next year.

It kind of depends on how the board, their workload is and how fast they can get to it.

Yes, in the back.

Good Morning, Ken Hoexter from Merrill Lynch.

Couldn't see you back there.

Can you possibly comment Hank on what the whole rate increases, or Don, would be without the contracts, just to grasp what aggressive pricing you are out in the market on renewing contracts?

A lot of interest in this coal pricing thing.

Well, it is pretty important.

I think the short answer to that Ken is no.

Obviously with respect to those two particular customers there is a public record that is available.

I would refer you to that public record, but I don't think it'd be appropriate for us to comment more specifically than that.

Right.

Hank while you're up there just two quick ones.

Can you talk about the status of the Conrail breakup on the accounting side, and then secondly when you just commented on pulling forward locomotives, are you pulling forward all 100 locomotives that you average per year?

If we're able to-in answer to your second question first, if we're able to, the expectation is that we will try to take delivery of at least 100 units by the end of the year.

With respect to your first question, we continue to progress and try and work on taking those actions that we need to in order to affect the restructuring or to visit reorganization of Conrail.

We have approval from the STB and we also have a letter ruling from the Internal Revenue Service.

So there are a number of things that we're going to have to do to give affect to that restructuring.

We're in the process of doing that.

Hopefully that's going to be completed before the end of this year.

Actually I had hoped to be completed mid year but I'm not sure that that's likely.

What we will do is, in all probability, as we get closer to the time affecting that restructuring, probably call a special meeting or have a special meeting for the financial community where we actually sit down and talk about the nuts and bolts of what we're going to do in terms of reallocating the accounting within our income statement.

Some of you may recall that in-I think it was this room that Marta Stewart, who was here today, did a tutorial some years ago on the accounting for Conrail, and I fully expect that she'll do another one a little closer to the split date so that the transparency and understandability of the numbers I think will be greatly aided by that when we get it done, and we'll obviously, therefore we'd like to do it as soon as we can.

But we're not in control.

Just a quick follow-up too on Don's part.

We always talked in the past about the percent of the average revenue per carload that's same store sales pricing increases, versus the overall pricing increases.

Can you comment on that because now that it's up, obviously you're getting the benefit of mix changes as well.

I'd like to talk about same store sales, Don.

Well, certainly we've got a combination on length of haul mix and price yield.

If we go back and look at our continuum, not just this quarter, but look at the past, merchandise revenue per unit is up 12% over that period of time.

We've got others in that same percentage as we track along.

So, this is a continuous process, it's not something that we work on each quarter, it's something we work on continuously.

It's not a one quarter objective.

So we're addressing pricing as we go forward, and as I mentioned, sometimes it's difficult to really measure same store increases versus new.

We have an internal measurement of base business and variable business.

We try to track that but frankly it's a difficult thing to track.

But we don't turn down profitable short moves because they're short moves and that.

We don't become obsessed with the overall numbers.

We look at everything on a case by case basis and make sure it's profitable and take it.

Yeah Tony.

Thanks.

I just would like-Steve just maybe answer part of this-but I was wondering if you could quantify the positive and what I might expect maybe some negative impact on the volume of the problems of your eastern neighbor service issues, whether you picked up some share because of that, or whether that's cost you some issues because of congestion.

And also you made some mention of the positive impact of truckloads issues, can you quantify that at all?

Are there any concrete examples of shippers who have come to you because of lousy service or other specific capacity issues in truckload.

I think I'll just take the second part of the question first, Tony.

With respect to the conversions in the first quarter, I mentioned the 44,000 Intermodal loads, which is about twice the run rate that we had last year of conversion.

And also in the carload business, we had about in the range of 20,000 truckload conversions.

So that's about $30m based on average unit, revenue per unit in Intermodal carload that we were able to convert, and that's a very clear focus that we have, and we're more focused on that obviously than looking at taking share from another railroad.

We've traded dollars in the past, and frankly I would rather look at highway opportunities and really generate real growth, and that's what we're focused on.

What we've expressed I think that philosophically the-we see that the big volumes, the big dollars our there are in our-traffic's being handled by trucking competitors, much of which we think we can be very competitive in, and our objective is to do that.

I think a quarter like this, when you analyze-when you parse though the numbers and the market share and things like that, I think you'll find that this is a good example of how to grow your business both because your customers are being successful, and you're growing business with your traditional customers, but also that there are conversions.

We know the individual areas where we've converted business from the highway, but for obvious reasons we'd rather not talk much about specific instances.

But overall there's no question that this is an environment in which it helps us to do that and our belief is that when the environment is right for it you do it.

Don did you have something to add?

I missed the first part of your question.

And I will come back to that.

In terms of the share vis-à-vis our eastern rail competitor, and interline partner, watching the CS54 data, the double AR data very closely, we do that, and I'm sure everybody in the room does it.

There hasn't been significant shifts on the carload side, and share between the two carriers.

There's been miniscule shifts on the Intermodal side, but I think those numbers reflect what I was just talking about which is the focus on the highway.

Yes.

Good morning David.

Two quick questions.

Is there any concern, other limitations outside of availability of locomotives in terms of, you know, other factors that may limit top line growth in 2004 if the economy picks up [on minimum].

You've obviously heard about UP talking about crew shortages, is there anything else you're concerned about that would limit you top line growth?

Well, I think the story is we're concerned about lots of things, but I guess our principal concern always is how is the economy going to do.

Clearly we're saying we have just seen a quarter here where it shows that we can do well in a strong economy.

We think that assuming the economy continues that strength, naturally if the economy weakens then that impacts us down the road.

We have concentrated hard as you know.

We talked about that last year when we brought on our train and engine crews in retrospect, earlier, and you'll recall in the early part of last year we had some compensation expenses that were attributable to the training of crews before we were able profitably to employ those crews, and that was painful at the time.

Now, it helps because while I guess we always see some, Steve, some areas of pressure on train and engine crew, we have for the most part not experienced that, and we are-I guess I would say, aggressively hiring, adding train and engine employees-do you remember the number Steve?

Why don't you stand up and talk to this a minute.

Steve said 1500.

We had a little over 1500 T&E employees last year, and anticipate something just south of that for 2004.

Of course depending on business volumes and also how our businesses are impacted by mix, which in an economy that's as volatile as we believe this one to be, has an impact.

So we'll continue to monitor that.

We think we have good jobs for train and engine crews, we're aggressively hiring, that's a good news story.

At the same time we're very mindful of our overall productivity and our overall improvements when you look at the overall employment numbers you'll see that they are down quarter to quarter, notwithstanding the fact we have added our train and engine employees, and that of course, is why we did the aggressive, non-union early retirement plan and achieved the productivity improvements last year.

And we now see the benefits because we're able to maintain some discipline in our overall cost structure, and that's why you concentrate so hard on productivity.

At the same time that I'm delighted to be out adding people to accommodate the volume growth.

That's a good story.

I might add, John, that our overall employment is down by several percentage points.

So I was speaking strictly in reference to T&E.

Yeah, I think our overall employment is down 1.7% quarter-over-quarter although the [inaudible] and engine employment is up 3.5% year-over-year.

So that's the story.

All right.

And lastly, I don't want to tie you into a specific number, but you talked a lot today about consistency-that's been a common theme in your comments.

All the trend lines are going in the right direction.

The pricing is getting better, the economy is getting better, and I guess from a consistency perspective-should we be looking for an operating ratio more consistently that begins with a 7 than an 8 going forward more so than we have in the past?

And I guess I'm asking, is this the inflection point-is this your toughest quarter of the year?

Is this the inflection point where we should see this kind of continual improvement?

Well the reason you hear me in my opening remarks, be a little cautious about that is we clearly achieved a substantial improvement in the operating ratio quarter on quarter in the first quarter.

And it started with a 7.

And you know me well enough I think to know that if we demonstrate that that is possible in a first quarter, we would certainly concentrate on seeing that that's possible in succeeding quarters.

But that was a very significant reduction in it, and we need to prove to ourselves that we can do that.

Hank?

John, let me offer one helpful suggestion, because I know you are trying to get some idea of what the future looks like.

The carloading information is available on a weekly basis, and I would urge you to look at that very, very carefully because that's going to be the best indicator looking ahead as to whether we are able to go ahead and sustain that operating ratio in the [inaudible] level.

It has two components, and you know how hard we concentrate on the cost and productivity side, and we've talked a lot about that, and a good economy will help a lot.

Yes sir?

[inaudible] Intermodal.

Are you happy with the returns you're generating Intermodal, that's question number one, and part of that is, your other commodities seem to be doing well, and coal the outlook looks really good and you only have so much capacity and so much CAPEX to spend-does that put you in the driver's seat to maybe drive higher prices on Intermodal?

I'm very mindful that even in a good quarter like the one we are reporting today I am constantly mindful that we're not earning our cost of capital.

And we've talked before about our objective, our company objective, and my personal objective to drive towards returns that are fair returns for all of our investors and so, we, while we're pleased with the results we're not pleased with it, so I think that our constant objective is to attack that issue by improving the value of, and therefore what we can charge, for our services, because we understand that that has to be a value pricing proposition and that's why we work so hard on having consistent service levels and reliable service and that, because we believe that we can price accordingly and we certainly have our eye on that ball.

At the same time we keep our eye on the productivity improvement side so that we can get our numbers right.

But yeah, we're certainly going to concentrate on that.

And today's environment clearly is an environment in which we have a valuable product to sell because fuel prices are high, the highways are congested.

And I believe that the highway congestion issue is one that is going to be with us for a good long time.

That doesn't have an overnight solution.

That clearly is something that we can help with.

We can help all of our customers with the difficult issues that they face from that.

And as that impacts then you have fuel prices, and hours of service and other things that impact our competitors.

That gives us an opportunity, but it also gives us some more valuable product that we can sell.

[inaudible question]

No, you don't have that right.

We are seeing Intermodal become more attractive every day, it's a huge growth business for us.

And we're not in the practice of growing businesses that are not profitable businesses, and not businesses that we think we can make very profitable.

And I believe over time Intermodal is going to become a larger and larger business.

And I say that at the same time that we're also aggressively growing our industrial business and our general commodity business, and our coal business.

Because all of these are profitable businesses, our objective is to make them all more profitable, and we certainly believe that Intermodal is one where our opportunities are enormous both to grow the business in terms of size, and to make it more and more profitable as we make it more and more valuable and work out the partnerships with our trucking, with many of the trucking companies that increasingly see the value of using our Intermodal services.

So there's a good equation there.

I don't know what the end of that equation is, but the factors seem to be right and we're going to push it.

Any other questions or comments?

Well thank you for your attendance on a rainy day and we appreciate it, and I hope to see you next quarter with another good report.