Norfolk Southern Corp (NSC) 2004 Q3 法說會逐字稿

I'm David Goode, Chairman and Chief Executive Officer of Norfolk Southern.

I'm happy to welcome you to our 3rd quarter 2004 analyst meeting.

That's a little shorter title than I had when I last saw you.

Otherwise I haven't changed.

I'd like to welcome those who are listening by telephone conference call and I encourage everybody as always to get a microphone when you're speaking so that everybody can hear.

And I remind our listeners and participants on the internet that slides are available on our website in the Investor's section so you can follow along.

As usual, transcripts will be available from our Public Relations department as soon as possible and we'll also post them on our website.

The lawyers have asked that I remind you to please be advised that any forward-looking statements made during the course of this presentation represent our best good faith judgment as to what may occur future and the actual results, of course, may differ materially from those projected and will depend on a number of variables, some of which may be outside the control of the company, and of course please refer to our annual report or form 10-Q filed with the SEC for a discussion of those.

This has been an exciting quarter punctuated by several events.

And as you know, we recently announced key appointments within our management team, one of which I'm pleased to say is the appointment of Wick Moorman as President.

Wick is an experienced leader who started with Norfolk Southern more than 30 years ago and has wide exposure to all facets of our company.

I'm confidence that he will lead us successfully forward and take full advantages of the opportunities which we're seeing with our expanding markets and enjoying with our premiere transportation network.

We're fortunate at Norfolk Southern to have a strong and deep group of people to create a seamless transition to a new management team and in that spirit, I have asked Wick this morning to say a few words about Norfolk Southern's performance in just a few minutes and also talk a little bit about our team.

Additionally, I should mention that up front that the numbers you're seeing today include the impact of the successfully completed reorganization of Conrail in the 3rd quarter.

I think those of you who follow us regularly knew that was happening and you'll hear more about the details of those numbers from Hank Wolf in just a moment.

Now, let me quickly talk about this quarter.

This is one I certainly enjoy talking about.

With the exception of the Conrail item I just noted, this quarter's good results, which you see before you, are driven by strong business demand and effective operating results.

When we were last together here, I said we were optimistic that the traction in the 1st half would continue and of course that happened.

Hence, Norfolk Southern established financial and operation records again this quarter.

I'll just mention a few highlights of the numbers that you have in your hand or on the site.

First, railway operating revenues of 1.9 billion were the highest in our history, up 16% year-over-year.

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

That was up 51%.

Third, net income including the gain of the reorganization of Conrail was 288 million, or 72 cents a share.

Excluding that gain, net income was still 236 million or 59 cents per share, up a strong 72% over the comparable period last year.

Fourth, our operating ratio was 74.7%.

That's a 5.8 percentage point improvement over the 3rd quarter last year and the best for the new Norfolk Southern.

Fifth, performance metrics, while not as good as we expect, are still among the best in the industry, notwithstanding high peak season traffic volumes and the bad weather and other conditions you know about.

And lastly, our network fluidity continues to remain stable, even as we're handling more and more record volumes in October.

This is an ongoing challenge for all of our people and we'll dig into details on this and the other factors and the numbers shortly.

But by any measure, this was an extremely strong quarter for the company.

We demonstrated strength in the face of really robust peak traffic volumes and the other weather challenges, which you know about.

There is no question that this tested the metal of our people and network and it continues to do so.

Nevertheless, we're maintaining strong operating service performance.

That's a testament not only to our thoroughbred operating plan and its flexibility, but especially it's a testament to the abilities and effort of our people to continue to make the extra effort to keep service high we test the new levels of traffic in the peak season.

We continue to benefit from market-based pricing as our service levels remain good and the demand for our business increases.

Strength is broad and most important, the results that you're going to see in detail today are driven by our core business.

In the 3rd quarter, we handled 11% increase in car loading, with 5% additional train starts.

Now, as you know, that's good leverage.

Indeed, that's powerful leverage.

Also our service quality combined with demand supports the increase in revenues that you see in the 3rd quarter.

We continue to have a disciplined focus on improvement in safety, service and efficiency and we're not going to let up on that score.

The happy combination of revenues up 16% and expenses up 8% produces the 74.7% operating ratio in the 3rd quarter.

For the 1st nine months, our operating ratio has improved 5.6 percentage points, compared to the same percentage last year.

So we're making progress and all of you who follow us closely know how pleased I am to be able to report continuously improving operating ratios.

While there are factors that affect the ratio this quarter and we'll show you those in detail, I do believe we're seeing the benefits of our sharp focus on margins.

Of course our stated goal was a full year's operating ratio that begins with the 7 to go with annual revenues also beginning with the 7, and obviously we are now on a good course to see that occur.

Now, with those brief remarks, at this time, I'd like to turn the podium over to Norfolk Southern's President, Wick Moorman, to talk some about service and also about the senior management team organization and then after Wick, Hank Wolf and then Don Seale will give you lots of details.

Wick?

Thank you, David.

It's a pleasure for me, obviously, to be here and to represent such a talented team during what I would characterize as a very important time for our company and for the entire industry.

And I would like to begin by talking about our management team, many of whom are here today.

Most of the names and faces I know are familiar to you, but some of the titles and roles have changed since we last visited.

Two of our Vice Chairmen are here today, Hank Wolf, Chief Financial Officer, and Steve Tobias, Chief Operating Officer.

Ike Prillaman, our Chief Marketing Officer is out securing new business and wasn't able to be here today.

As a graduate of both Steve and Hank's remedial schools of management at sometime in my career, I'm delighted that they are here and continuing to give us very sound leadership.

Our team also includes our new Executive Vice President, Jim Hickson with Finance and Public Affairs.

Jim, as many of you know, came from our tax department, the breeding ground at Norfolk Southern at superior management, and I -- and has had important roles as you know in the past in administration and law, as well as tax.

Mark Manion, our Executive Vice President of Operations.

Mark has a long-time background our operating department and both in transportation mechanical.

Mark and I actually go way back to the wars in Greensboro, North Carolina many years ago and delighted that he has this position.

Kathryn McQuade, our Executive Vice President of Planning and our new Chief Information Officer.

Kathryn, as I think most of you know, has a background in finance, ruled our budgeting process with what I would describe as the iron fist and the velvet glove, and now I think has responsibility for a very intriguing group as we're combining all of our of our planning processes with the technology that we think will lead us forward.

John Rathbone, our Executive Vice President of Administration.

John has the financial background as well, with responsibility now for our all important HR and labor relations functions.

He also now has responsibility for public relations, which means that Bob Ford has to train someone else.

And finally, Don Seale, who is our Executive Vice President of Sales and Marketing.

Most of us just think of Don as one of the premiere people in the rail industry in sales and marketing.

His real secret is that he started his career spraying weeds on the right of way as a college student, I guess.

Also here to be of assistance today are Bob Ford, our Vice President of Public Relations, Bill Blanco, Vice President of tax, Marta Stewart, our Vice President and Controller, LeAnn Merillie [ph], our Director of Investor Relations, and Debbie Malbin, Hank Wolf's assistant.

We do have a depth of management talent and experience at Norfolk Southern as evidenced by all of the group that's here today.

All of us have worked together for many years in a number of capacities, and it's been a real privilege for me to work closely with everyone here throughout my career at the company.

I can say without reservation that this is as talented a group of managers and as good a group of people as I have ever had the good fortune to be associated with.

Going forward, you can expect that our collective commitment to excellence and management focus, to continue now and in the years ahead just as our customers can expect continued commitment to service improvements.

We firmly believe that these are the core values of our company and they will ensure our continuing success.

And obviously I encourage you spend some minutes talking the group after the program.

Now I'd like to make a few comments about our service performance, a subject in which everyone who follows our business very rightly has a strong interest.

As David mentioned, Norfolk Southern has been able to maintain strong service levels in the past quarter, despite some weather-related problems and in the face of continuing strong traffic volume.

Our network remains fluid, even as we handled some 183,000 additional units in the 3rd quarter, and a total of over 431,000 units for -- additional for the 1st nine months.

Through the use of our thoroughbred operating plan, the company continues to demonstrate its capability of adapting to changing conditions and shifting business demands and our people continue to execute according to the plan.

We're also continuing to invest in hiring additional train and engine crews and they are helping us to absorb this strong business growth.

Against all of this expansion area backdrop, our service metrics are among the best in the industry.

Our cars online have remained stable and while our system average train speed has slipped a little in September and October, our all-important dwell time management in the terminals has continued to improve.

Looking at October car loadings, we're still seeing strong volumes, even though we're now looking at stronger year ago numbers, and even in the face of these tougher year-over-year comparisons, our volumes are up, led primarily by intermodal metals and coal, with a caveat though, that like everyone else, we remain somewhat concerned about the effect of higher fuel prices on the economy.

We are comfortable that we continue to have the network capacity to handle these volume increases.

However, as you've heard us point out before, we may eventually reach a threshold where we will need to add capacity to handle increased volumes and our current traffic levels obviously have absorbed some of our capacity cushion.

We're continuing to be selective about accepting business that we are confident we can handle efficiently and reliably, and at prices reflecting the value we offer.

And in addition, we continue to analyze how to make point specific improvements to in ensure adequate capacity in our network on a go-forward basis.

I believe that our exceptional 3rd quarter and year-to-date results validate our strategy of providing higher value transportation products, driven by premiere operating performance and they show the importance to all of us of continuing to execute well.

As I said, we're committed to maintaining and improving our service quality to give Norfolk Southern a sustained competitive advantage and an increasingly valuable product going forward.

Now I have asked Hank to review our numbers and then Don will talk to you about the specifics of the market before we turn it back to David to answer questions.

I will give Hank a brief introduction.

Four of us here today, at least John, Jim, Kathryn and I, all went through Hank Wolf's managerial training program and I think he's very pleased with where all of us are today and we're all very pleased we survived it.

Thank you, Wick for that warm and kind introduction.

Good morning, everyone.

We're pleased with our 3rd quarter results that you're looking at.

The momentum that we talked about earlier this year has continued and as you'll see, a significant increase in our railway operating revenues allowed us to produce record results again this quarter.

As you may be aware, we completed the Conrail corporate reorganization, or Conrail spinoff on August 27th.

Before we get into the details of the quarter this morning, I'd like to discuss the impact of the Conrail restructuring, which is included in our results for the month of September and which produces a gain in the 3rd quarter.

Conrail reorganization resulted in a spinoff of assets previously leased to PRR in a tax-free distribution to Norfolk Southern on August 27th.

The divisive reorganization of Conrail was accounted for at fair value and the appraisal of Conrail assets resulted in a writeup of assets largely related to an appreciation in land values.

At the same time, Conrail's debt assumed by Norfolk Southern was recorded at fair value and because interest rates are lower now than they were in 1998 when we performed the original purchase accounting, the applicable accounting rules required a writeup in the Conrail debt.

Recording the property and debt at fair value resulted in a net after-tax gain of $53 million, or 13 cents per share, which is reflected in the net income that we're reporting.

Allow me to take just a few minutes to summarize for you the effect of that Conrail corporate reorganization and its impact on our balance sheet.

This is a comparison of our summarized balance sheet just before and just after the reorganization.

Our investment in Conrail was reduced by $5.5 billion.

The remaining investment in Conrail reflects shared asset areas, which, as you know, continue to be owned and operated by Conrail.

Our investment in the properties was increased by $8.5 billion, reflecting the direct ownership of PRR resident assets.

Debt was increased by $714 million, reflecting the addition of our share of Conrail debt.

Our total long-term debt at the end of the 3rd quarter was just over $7 billion and our debt to total capitalization ratio was 49 1/2%.

Intercompany debt due to Conrail totaling 834 million was extinguished in the Conrail reorganization transaction.

And with the addition of PRR assets to our balance sheet, deferred income taxes was increased by $3.2 billion.

The accounting for Conrail -- for the Conrail corporate reorganization resulted in a net gain of 53 million.

This slide provides a comparison of our income statement with and without Conrail -- the Conrail reorganization for the 3rd quarter.

The major shift occurs between Conrail rent and services and the depreciation lines in the income statement as a result of the change from leasing the assets to owning the assets.

As you can see, there is no bottom line effect.

I want to remind you that our income statement reflects the changes from the Conrail reorganization for only one month, so that the impact on the 3rd quarter is somewhat smaller than you can expect to see in future quarters.

In addition to the gain from the Conrail corporate reorganization, you may recall the 1st quarter of 2003 included a $114 million, or 29 cents per share after-tax benefit from the cumulative effect of two accounting changes and a $10 million, or 3 cents per share after-tax gain from discontinued operations related to our 1998 sale of North American Van Lines.

In order to provide you with the most meaningful comparisons for both the quarter and year-to-date, I'll initially exclude all of these items from my presentation this morning and then reconcile the totals to our reported results at the end of our remarks.

Now, let me turn to our results for the 3rd quarter.

Railway operating revenues for the 3rd quarter were nearly $1.9 billion, up 259 million, or 16% and were a record high revenues for any quarter.

Merchandise revenues increased by 95 million.

Intermodal revenues rose 89 million and coal revenues were up 75 million.

For the 1st nine months, railway operating revenues were a record 5.4 billion, an increase of 571 million, or 12%.

General merchandise revenues were up 225 million.

Intermodal revenues increased by 192 million, and coal revenues rose 154 million.

Third quarter volume increased by nearly 183,000 car loads, or 10.6% compared with last year, driven by 132,000 or 21% gain in intermodal units, which resulted in our highest quarter ever for intermodal volume.

In addition, revenue per unit increased by 5.1%, resulting in a total increase in railway operating revenues of 16.2%.

For the 1st nine months, car loads were up approximately 431,00 units, or 8.4%, largely driven by a record $302,000 unit, or 17% increase in intermodal volumes.

Revenue per unit was up 3.2% and total railway operating revenues improved by 11.9%.

And Don Seale is going to provide you with the details of our railway operating revenues in just a moment.

Railway operating expenses for the 3rd quarter were $1.4 billion, up 101 million, or 8%.

For the 1st nine months, railway operating expenses were 4.1 billion, 171 million, or 4% higher than last year.

As you can see from this graphic, the largest increase in railway operating expenses for the 3rd quarter was in material services and rents, which rose 65 million, or 19%.

This increase was primarily driven by the increased volumes that were handled during the quarter.

Within this category, purchase services increased 31 million, primarily due to higher volume related intermodal costs, such as terminal lifts and [inaudible].

Equipment rents increased 24 million, in part due to the increased traffic volume, but also due to the absence of favorable adjustments for equipment bills that benefited 2003.

Materials costs were 10 million higher due largely to locomotive maintenance and freight car repairs.

The next largest increase in 3rd quarter operating expenses was in compensation and benefits, up 39 million, or 7%.

This increase was driven by increased hours for train and engine employees and higher wage rates, which collectively added $19 million.

Higher stock-based compensation expense rose by 10 million as our stock price increased.

Higher incentive compensation of 7 million, approximately half of which was for our locomotive engineers.

Reduced pension income that was $5 million lower than last year, and other miscellaneous items that added $6 million.

These items were partially offset by $8 million in savings from our reduced non-agreement.

Depreciation expense increased by $22 million, or 17% in the 3rd quarter.

As you can see by the offsetting decline in Conrail rents and services, this increase is primarily the result of the Conrail reorganization.

From now on, the cost of our direct ownership of the assets is reflected in depreciation rather than in Conrail rents and services.

I would remind you that this change in classification only affected one month this quarter.

Consequently, you should expect to see an even larger shift between these lines next quarter and beyond.

Diesel fuel expense was up $12 million, or 14% compared with last year.

This increase included the favorable impact of fuel hedging settlements of $41 million and a one-time credit of 8 million for an interline fuel recovery.

As you can see, our average price per gallon for diesel fuel increased from 77 cents in the 3rd quarter of last year to 88 cents this year.

Consumption of approximately 121 million gallons was 8% higher in the quarter on an 11% increase in traffic volumes.

During the 3rd quarter, 86 million gallons of fuel were hedged at an average price per gallon of 82 cents.

We have nearly 78 million gallons hedged in the 4th quarter at an average price per gallon of 84 cents.

In the 3rd quarter, we had hedges in place for approximately 71% of our diesel fuel requirements and the 3rd and 4th quarter is approximately 61% hedged.

We have not entered into any hedge transactions since May and as we go forward, our hedge position will diminish as a percentage of our fuel consumption unless we enter into new hedge agreements.

Absent a decline in oil prices, one should expect our average cost per gallon to rise and our total fuel expense per quarter to increase.

Casualties and other claims declined 13 million, or 30%.

This decrease was partially due to reduced accruals for loss and damage claims and personal injury claims.

As a reminder, last year's 3rd quarter was burdened with unfavorable personal injury claims developing.

For the 1st nine months, railway operating expenses were up 171 million, or 4%.

The largest increase for the year-to-date was in compensation and benefits.

In the 1st nine months, we experienced an $88 million, or 6% increase in compensation and benefits compared with last year.

Principally as result of higher wage rates that increased wages by $25 million, increased T&E hours that added another 21 million, increased stock-based compensation expense of 19 million, higher incentive compensation of 16 million for non-agreement employees, and an increase of $15 million in the bonus for locomotive engineers.

Reduced pension income of 10 million and other miscellaneous items of 4 million.

These increases were in part offset by the reduced non-agreement work force that saved $22 million.

Materials, services and was the second largest expense increase for the 1st nine months at $82 million, an increase of 8%.

Equipment rents were $15 million higher.

Materials were up 26 million, and purchase services climbed 41 million.

As in the quarterly comparison, these increases were largely volume-related.

Diesel fuel expense was up 28 million, or 10% reflecting a 7% increase in consumption, combined with an increase in the average price per gallon from 81 cents last year to 86 cents this year.

The hedges that we had put in place over the last two years helped to constrain our diesel fuel expense as we saw fuel prices surge to new record levels.

Depreciation expense increased 25 million and Conrail rents and services declined 32 million.

Both largely a result of the change in accounting that reflects the Conrail corporate reorganization.

Other expenses were up 13 million, or 8%, reflecting higher property and sales and use taxes.

And finally, casualties and other claims were $33 million lower year-to-date and, again, you'll recall that last year's expenses were burdened with unfavorable claims development as well as some higher derailment costs that we had in the 1st quarter of '03.

The railway operating ratio for the 3rd quarter was 74.7%, our best quarterly operating ratio since the Conrail integration.

The railway operating ratio for the 1st nine months was 76.9% compared with 82.5% for the same period last year.

Income from railway operations for the 3rd quarters a record 469 million, up 158 million, or 51% over last year.

For the 1st nine months, income from railway operations was also a record at more than $1.2 billion, up 400 million, or 48%.

Not only is this a nine-month record, but it also exceeds the previous full-year record for railway operating income.

Turning to our non-operating items, total other income and expense for the 3rd quarter was an expense of 134 million, compared with an expense of 111 million in '03.

Gains from sales of property and investments were 9 million compared with 4 million last year, an increase of 5 million.

Coal royalties of 11 million were up 1 million over last year.

All other was an expense of 33 million compared with an expense of 2 million last year, reflecting the expenses related to investments in synthetic fuel facilities that we announced last quarter.

As you recall from our discussion then, the increase in other expenses are more than offset by reduced income taxes .

Interest expense on debt was 121 million, which was 2 million lower than last year.

And I'd like to remind you that as part of the Conrail reorganization, Norfolk Southern exchanged newly-issued bonds for 58% of Conrail's debt and entered into subleases with respect to the secured debt of Conrail.

So in the future, the interest on that debt will be reflected in interest expense on debt rather than being embedded in Conrail rents and services as it has been in the past.

For the 1st nine months, total other income and expense was an expense of 366 million compared with an expense of 316 million in '03.

Gains from sales on property and investments declined by 1 million, while coal royalties increased by 2 million.

All other was an expense of 49 million, compared with income of 12 million in '03, primarily due to expenses from the synthetic fuel facilities investment as well as the absence of favorable interest accruals related to prior year's income tax liabilities that we had in '03.

Interest expense on debt for the 1st nine months was 363 million, 10 million lower than last year due to less outstanding debt.

Third quarter income before income taxes was 335 million compared with 200 million last year, a 68% increase.

For the 1st nine months, income before income taxes was 874 million, up 67% compared with 524 million last year.

The provision for income taxes for the 3rd quarter was $100 million compared with 63 million in the 3rd quarter of '03.

The effective tax rate was 29.9% compared with 31.5% last year.

For the 1st nine months, the provision for income taxes was 268 million compared with 165 million last year, and the effective rate was 30.7% compared with 31.5% in '03.

Lower effective tax rates were largely attributable to the effect of the synthetic fuel investments that I referenced earlier.

Third quarter net income excluding the Conrail reorganization gains was 235 million, which is 98 million, or 72% higher than the 137 million earned last year.

For the 1st nine months, net income was 606 million compared with 359 million last year, an increase of 247 million, or 69%.

This slide highlights the components of the change in net income for the 3rd quarter.

Railway operating revenues increased 259 million, while railway operating expenses rose 101 million.

Other income net decreased 25 million, interest expense on debt declined by 2 million, and income taxes were 37 million higher, yielding a $98 million increase in net income.

For the 1st nine months, a $571 million increase in railway operating revenues was offset by $171 million increase in expenses.

Other income net was 60 million lower.

Interest expense on debt was 10 million lower and the provision for income taxes was $103 million higher.

Combined, these items generated $247 million more in net income.

Diluted earnings per share for the 3rd quarter were 59 cents compared with 35 cents per share last year. 69% increase.

For the 1st nine months, diluted earnings per share were $1.53, which is 66% above the 92 cents per share earned a year ago.

This slide reconciles the net income and earnings per share for the 3rd quarter, excluding the effect of the gain from the Conrail reorganization to our reported net income of 288 million, and earnings per share of 72 cents.

And this slide reconciles the net income and earnings per share for the 1st nine months to our reported earnings, excluding the gain from the Conrail reorganization this year and the effects of the accounting changes and income from discontinued operations that we announced in the 1st quarter of '03.

Both of these reconciliations are posted on our website for your reference.

Reported net income for the 3rd quarter which includes the Conrail reorganization gains is 288 million, or 72 cents per share compared with 137 million or 35 cents per share last year.

The 1st nine months reported net income was 659 million, or $1.66 per diluted share, compared with 483 million, or $1.24 per share.

Thank you for your attention and now I'd like to turn the program over to Don Seale is going to give you an in-depth report on our railway operating revenues.

Thank you, Professor Wolf.

Good morning.

It's good to be back with you again to report on our 3rd quarter commercial results.

While the economic recovery moderated somewhat during the quarter in the face of $50-plus oil prices, the freight market obviously continued to be strong with solid opportunity for growth.

During the 3rd quarter, our revenue and volume generally outpaced the performance of the economy, as increased volume and improved yield drove substantially higher results.

Third quarter revenue grew 259 million, or 16% to a record $1.86 billion.

With the exception of agriculture and automotive, all of our remaining business groups achieved record quarterly revenues.

For the nine months, revenue of 5.36 billion was up 571 million, or 12%.

As a point of comparison, over the past 12 months, revenue has now increased by $666 million, or 10% after posting a gain of $198 million, or 3% for the same period of 2003 versus 2002.

Total volume for the quarter increased 11%, and 8% for the year-to-date.

Intermodal produced another record volume quarter, up 21% for three months and 17% for the year.

Intermodal's growth of 132,000 units for the quarter accounted for 72% of our total volume gain, while merchandise increased by 29,000 car loads, or 4% for the quarter.

And coal was up 21,500 loads, or 5%.

We have maintained strong monthly comparisons throughout the year and since February, our volume gains have ranged from 6 to 12%, with higher monthly volumes as the year has progressed.

The 3rd quarter ended with an all-time weekly loading record and that pace continues in October as loadings through October 10th set a new 52-week high and the week ending October 18 was our second highest.

As previously stated, revenue growth for the quarter was driven by higher volumes and improved yield.

As our overall service performance continued to enable us a better price to the market.

Revenue increased at a higher rate in the 3rd quarter versus year-to-date in all of our groups with the exception of automotive.

Third quarter revenue per unit reached a record of $975, increasing $47, or 5% over last year and $969 for the nine months of $30 or 3%.

Our business groups all achieved revenue per unit gains of at least 4% over the 3rd quarter of 2003.

Intermodal's growth was driven in large part by our service products and network capacity.

Strong demand continues to be drive by the convergence of an expanding economy, led by higher consumer spending, higher industrial production, and international trade, coupled with constraints in truck capacity.

We've also successfully aligned our international services with east coast ports, allowing us to benefit from the continuing trend to all water service from the pacific rim to the eastern U.S. markets.

Our domestic volume comprised of asset-based carriers and intermodal marketing companies, grew 24% for the quarter.

Premium business, which includes parcel and LTL carriers grew 20%.

International steam ship volume was up 22% and our truckload sector was up 27%.

For the quarter, intermodal revenue reached $404 million, up 28% over 2003 and 1.1 billion for the year, up 21%.

To add greater context, over the past seven quarters, our intermodal revenue base has grown by 40% and we continue to be optimistic about the opportunity to build on this growth in the months ahead.

Going forward, clearly our challenge and opportunity across all of our intermodal business is to appropriately manage demand with service, pricing and capacity.

We're actively engaged in yield management throughout our business to ensure that capacity goes to its highest and best use with customers that help cycle our asset the fastest.

Also, as we've stated previously, for both the intermodal and merchandise car load sectors, we continue to see the highway as a significant source of growth opportunity.

During the quarter we estimate that highway conversion of approximately 59,000 truckloads generated $42 million in revenue.

That equates to approximately 16% of 3rd quarter --of the 3rd quarter revenue increase that we sustained.

In total, intermodal generated nearly 31 million in highway diversions for the quarter and 70 million for the nine months.

Driver shortages and trucking capacity constraints continue to create rail opportunities in our car load sector as well, with approximately $12 million in new business secured in the quarter and 32 million through the 1st nine months.

I remind you that these are net of any conversions from rail to truck, so they are net conversions.

Looking at our merchandise groups in more detail, revenue reached $1 billion for the quarter, up 10% and 3 billion for the year, up 8%, with volume and price contributing equally to the overall increase.

Volume rose 4% for both time periods, with revenue per car increasing in the 3rd quarter.

As in the 2nd quarter, continued manufacturing expansion had a positive impact in our metals, construction, chemicals and paper markets.

Our metals and construction markets have seen strong growth throughout this year, leading both revenue and car loop volume improvements in our merchandise sector.

Increased production at NS served integrated steel mills, mini mills generated significant improvement in domestic iron and steel, coil and scrap shipments.

Increased volumes for a broad range of construction and aggregates markets also helped drive growth.

Chemicals volume across all markets has been stronger throughout the quarter and the year-to-date, as manufacturers increase demand for feed stock.

Plastic shipments are higher, as inventories are restocked in anticipation of higher product prices relating to increasing natural gas costs.

We're also encouraged by new plastics production coming online at NS serve plants that will bode well for future growth in this commodity.

Revenue growth in our paper markets has been driven primarily by yield improvements across all segments.

Third quarter volume was somewhat tempered by disruptions, resulting from the storm activity in the southeast, but on a positive note, newsprinted printing paper shipments were up 3% and 9% respectively.

Increasing ethanol and fertilizer shipments continue to drive volume and revenue improvements in our agriculture market.

Ethanol shipments increased 84% for the quarter and 64% year-to-date, and fertilizer was up 8% for the quarter and 9% for the nine months.

The grain market has become even more dynamic as most of you know, we're in the middle of a record corn harvest, and one of the largest soybean crops as well, which include substantial harvest in the southeast, Pennsylvania and Maryland.

Longer haul corn and soybean business to processors is being converted to shorter hauls as this heavy local crop comes online.

This record grain crop will provide additional opportunities for increased volume during the 4th quarter and going into 2005.

In our automotive market, slower sales and higher inventories at several Ford and General Motors plants resulted in production cuts and plant downtime.

These factors were the primary drivers for a 2% decline in volume for the quarter.

Third quarter production was down 7 1/2% for Ford, 5% for General Motors and 2 1/2% for DaimlerChrysler.

In addition, slower than expected ramp-up of shipments of new models from Ford at Chicago and Dearborn, Michigan, negatively impacted our volume.

Increased business with international producers helped offset the challenges that we face with these production cutbacks.

Higher production at Honda's second assembling plant in Lincoln, Alabama and Toyota's expansion at Princeton, Indiana, coupled with ongoing improvement in yields produced a 2% increase in revenue for the quarter in automotive and a 3% gain for the 1st nine months.

Looking ahead, 4th quarter production is projected to be down 12% at Ford, about 9 1/2% at General Motors.

DaimlerChrysler's release of containment vehicles and higher shipment levels at Ford, Chicago and Dearborn as Honda in Lincoln, Alabama, will continue to help buffer some of this impact.

Coal volume increased 5%, as gains in utility, export in melalurgic coal more than offset declines in industrial coal, Coke and iron ore.

For the year-to-date, volume is up 3%, driven by 32% gain in export shipments.

In addition to car load growth, coal transportation demand is increasing due to longer hauls.

For the quarter, coal sourcing shifts to longer haul markets has increased total ton miles by approximately 9 1/2% compared to 5% increase in car loading.

Utility coal demand remains solid during the quarter, as utilities attempted to replenish low stockpiles ahead of the coming winter season, while increasing burn to meet heavier electricity demands.

Nationally, electricity production is up 1 1/2% so far this year and is up 2.2% in the southeast.

Coal supply of production continue to be a challenge in the east, especially for low volatile metalurgical coal.

And Appalachian coal production has increased by 3% for the year, which is an encouraging sign as we look ahead.

Export coal volume was strong in the quarter, increasing 49% due to sustained global demand for high quality metalurgical coal.

Other ocean vessel rates continue to favor U.S. coals.

On the demand side, China's growing consumption of coal for steel production and for electricity generation has kept the global markets extremely tight.

On the supply side, coal mine permitting issues and production problems constrained coal supplies in the east.

Abroad, Australian coal supplies were tight due to production shortages.

Polish coking coal exports also declined with privatization closing some uneconomic mining operations.

Looking ahead, coal export purchases are already being negotiated for 2005, with higher pricing most likely.

Coal for the industrial markets was down 6% for the quarter, but up 4% year-to-date.

The decline in the quarter was due primarily to competition from natural gas and sourcing changes.

Looking at our domestic steel markets, metalurgical coal demand remains strong as volume grew 9% for the quarter and 6% year-to-date.

Inventories at steel mills and Coke plants are low or nonexistent and coal pricing continues to rise.

Coke and iron ore volumes were down 13% and 6% respectively for the quarter, mostly due to reduced production at NS served works and steel.

Demand for coke and iron ore should continue to improve as we look ahead, as warrant consolidated industries recently completed a $15 million reline of their furnace at Warren, Ohio and the international steel group has now restarted a second blast furnace at Weirton, West Virginia that will increase steel-making capacity at that plant.

Finally, we anticipate the completion of the new sun coke coking batteries being built at Haverhill, Ohio early next year, April 2005 is the projection, which will create significant new inbound coal and outbound coke business and a greater supply of coke to our steel customers.

In summary, it's very gratifying to see the high level of demand in value that our service has in today's marketplace.

We have recorded revenue growth of $571 million in the last three quarters and 666 million over the past 12 months.

This is approximately three times the rate of growth we saw in 2003 versus 2002, and our October volumes continue to track upward.

Our focus ahead will continue to be on providing the right service products at the right price and value.

Thank you very much.

David?

Thank you, Don.

Thank you for your patience.

That's a lot to put on the plate, but it was quite a quarter and we wanted to put it all before you.

So we'll be glad to take any questions from the house.

Yes, Tom.

Yeah, two different questions.

First of all, congratulations.

Very impressive results.

Thank you.

Let's see, on the pricing side, the yields, I think the coal was noticeable, revenue per car up about 14% and intermodal was also quite strong.

I wonder if you can give me a little breakdown on that, how much is fuel surcharge, how much is length of haul, how much is true price?

You know, any rough kind of comments on that and just to give us a sense, are these types of rates sustainable or were there some factors that caused these yield growth numbers to look a little better this quarter than they might in going forward.

I think Don would be glad to give you some general comments on that.

Well, on the coal side as I state in the prepared remarks, our length of haul extending.

Our ton miles is up 9 1/2% on growth of 5% increasing car load.

So that's a component of the revenue per car.

Obviously we continue to work very diligently on the yield side and I think you're aware of the activity that we have in that regard.

And certainly mix, both on the metalurgical coal as well as utility coal and the mix of export to the total base of business, that impacts the yield with respect to coal and fuel surcharge is the final component of that.

Looking at our intermodal business, you saw that we were strong in all segments, that's a combination of volume, but it's also a combination of a real clear focus on the part of all of us with respect to improving the yield of that product, also the fuel surcharge, also the mix of traffic, length of haul.

So when you put those together, those are the components that are driving the increase in yield.

Across not only intermodal and coal, but merchandise as well.

Is there any reason to think those factors are not sustainable or that a component of those was unusual in the 3rd quarter or are those factors probably continue to work in your favor?

We don't see anything unusual with respect to the 3rd quarter, but I would say that crude oil prices being at $53 a barrel, we continue to watch that impact with respect to what that may do to the economic growth.

We noted that the ISM index declined for the past couple of months.

We've been telling you that it had sustained levels above 60 for nine consecutive months.

In August and September it declined.

We're watching that closely.

That still tells us that manufacturing is expanding, but it's expanding at a less rapid pace than we saw over the past nine months.

But nothing in the 3rd quarter that is unusual with respect to our approach, our note of caution would be where the economy might go.

We see the market quite robust and we see the market containing significant opportunities for us.

Can I -- one more either for David or Steve.

On the capacity side, again, very impressive leverage.

I think you said 11, you know, 11% type of growth and only 5% train starts.

Is that something that you think can continue?

Is there still enough capacity in the network to see those types of leverage numbers over the next few quarters?

We can, we continue as we've said to you, we continue to work to see how much capacity we can develop in our system and as we've said before, obviously we're filling out trains, which is the best way to utilize capacity and to run the trains, and the train network efficiently is the next best way to add capacity.

We don't -- we continue, I guess, to surprise ourselves in some ways about the, how effective Steve's people and all of our people are in maximizing the capacity of our network.

We can, you know, we're cautionary about that because we're seeing traffic levels that we haven't seen before and so we're -- we're being very careful as we add traffic to make sure that, make sure that we can handle it effectively, but we think we've got some room to go.

Steve, why don't you supplement that.

It's a challenge for us, but a good challenge.

David's clearly hit the high spots.

This is a managed process and it's certainly, as you know from our industry and operations of other companies, there are resources that we put against the demand, namely people and locomotives and equipment.

We're trying to stay ahead of those curves and I think we've done a fair job of doing that in the original setup of the top plan of putting capacity in the system.

Is there capacity left?

Yes.

Do we have the opportunity to apply different resources to expand and significantly enhance greater volumes?

In my view, yes.

Clearly this is the challenge of the industry right now and we're in -- and we're in with it, but boy, this is a -- compared to the challenge of the shrinking industry this, is a challenge that I love to address.

Yes, in the back here.

Question on capacity.

You guys have bee taking market share all year.

I assume some of that has been benefiting from some of the problems of your competitor.

To the extent -- is there business in your system that you see potentially at risk as surface levels improve in the neighborhood and, you know, how do you manage that process, things we should look out for?

Actually what we believe we are seeing is, is we are, we are benefiting.

Obviously high fuel costs make people want to use rail transportation services because of the inherent, inherent advantage of doing that, coupled with theer factors that are going on that everybody knows about, including highway congestion and driver situations and some equipment shortages.

So we think that we are -- we think that what we are seeing is a, is, in our market share, improvement is an improvement in our market share vis-a-vis the, the conversion from highways.

So we think that's -- we think that's the strength of our business.

The -- so how sustainable is that?

I think -- I believe that we are seeing some, some long-term sustainable trends that are developing and when we talk to our partners in the trucking business and we have more and more good partners in the trucking business that want to work with us closely in developing business.

There are a lot of factors that indicate to us that we, that we need to concentrate on these capacity issues that we were just talking about because we think that there are some things that happen, clearly on the coal side as natural gas continues both to be expensive and in short supply.

We see that there is a lot of momentum that will continue in that market, and obviously that's a market in which we, our services are both needed and valuable.

So we think there are some trends here that are sustainable, but as Don points out, on the other, on the other side of it, we worry, as everyone else does, about the overall effects of high, continuing high oil prices on the general economy because in the final analysis, we do well as the economy does well.

And just to follow up on fuel, where are you in terms of book of business that's protected in one form or another from surcharge mechanism and then also as your fuel hedges drop, should we assume that you've got the incremental pricing power to essentially, you know, keep fuel from biting into the OR?

Do you want to make a comment about that?

We -- we disclose what we can to you with respect to these, but obviously some of this is competitive information.

Yeah, generally we don't talk in terms of what percentage of our contracts reflect the benefit of the fuel surcharge.

Those surcharge rates are numbers of public knowledge.

On the fuel hedging side, we have not entered into any hedges since May, so we are attributing, if you will, the target 80% level that we had when we put the program in effect.

And one of the reasons that we're doing that is we're looking very, very carefully at the integration of the fuel surcharges and the hedging program because if you're not careful, what you can do is you can increase the volatility of earnings rather than reducing it, and our objective in the hedging program when we initiated it was to reduce the volatility of earnings and so we're trying to manage the process of integrating fuel surcharges and fuel hedges to continue to achieve that result.

We don't think we're any smarter than anybody else with respect to where oil prices are going, but we are trying to manage a program that will keep us from the, from the extreme volatility, which we and others saw in the past.

So it's -- and we don't -- nobody likes surcharges.

We don't either.

But they are necessary factor for us and one that's reasonable and we do try to manage.

Yes, Tony, you had a question.

Yeah, I just wondered if we could get an early look at CapEx in the next couple of years and what the growth component might be out of that.

I know y'ou're already thinking about next year, but related to the capacity issues, where do you guys think you're going to be in the next several years?

We're taking a look.

We are, as you say, we are right in that, in that process now and we're not -- and we are seeing where we can, where we can take that and where it goes.

Hank, why don't you comment on that.

Tony, I think if I can be of some help to you and to your colleagues, it would be to say that obviously between 2000 and 2003 with very sluggish business levels with very little growth in revenues we continue to maintain the property in good order.

I think we have a reputation for that.

We continue to make purchases of new locomotives, maintain the track structure and so forth, but did not really go overboard in a number of other areas.

And we had a great deal of capacity that we built into the system as we prepared for the Conrail integration and had stepped up CapEx prior to 1999.

As we go forward, if these business levels continue, it's obvious that it will demand increased spending for incremental capacity at intermodal terminals, for passing sitings perhaps to avoid any congestion problems.

Those are things that are all on the horizon.

It's not something that necessarily is coming next year or even the following year, but as we see our business expand, we have to be prepared to accommodate that business and continue to provide the highest levels of service to our customers and we're prepared to do that.

I think that this year we will top the billion dollar mark in CapEx because we took an advance purchase of our 2005 locomotives in the 4th quarter of this year.

But we're right now in the process of evaluating what our business plan looks like for next year and trying to coordinate the capital budget to dovetail it with that business plan.

And obviously we'll be having an announcement in the near future, but I think probably just generally, slightly higher than what it's been, but it depends on where the business volumes go before we can really define how high that will be.

Neither we nor anybody -- I think nor anybody else foresaw how robust the growth in business volumes would be this year, and we are -- Hank and I, as those of who you follow us regularly know, had some pretty strong commitments in our own, in our own approach to doing things like reducing debt and getting our balance sheet in good order.

We have made very good progress, I think, towards doing that and continue to do so at the same time, we've got a lot of commitments to our shareholders to improving our shareholder returns, and we are making progress in that.

But it is -- it also, when you look at a year like this year, it is clear that a core advantage of a company like ours is our ability to accept traffic volumes when the economy brings them to us and we need to have, and we need to handle them.

The economy needs that.

Our shippers need that, and as you look around you, the primary thing we do is move freight.

That's our core competence and at the top of our list is to maintain, make sure that we have the ability to continue to do that safely, efficiently and at service levels that enable us to price our business at appropriate levels when the economy needs it as it does now, and that's -- that's obviously a difficult management challenge, but that's the business we're in and we're spending a lot of time addressing how efficiently we can maintain our ongoing capital needs at the same time we keep this business rolling as it needs to do.

David, I have one more.

Yeah, do you want to follow up?

I'm sorry.

Just a quick one.

Not that you guys are a major intermodal player versus, you know, these kind of enormous numbers, where do your margins and returns in intermodal compare within your own book of business?

How do they rank and then where is the trend line going?

Well, I think you know we're probably not going to answer that -- that directly, but -- because we don't disclose our margins and wouldn't want to in any particular line of business because all of this is, is a very competitive business we're in, as you know, and so -- but it would be -- it would be fair of you to think, as you look at these numbers and see double-digit growth in our intermodal business with the first digit of that double digit beginning with a two this quarter and at the same time that we show improvement in operating ratio and other factors, it would be reasonable of to you think that the value of the intermodal product that we're offering now is, has good value and it's good value that -- that drops good returns to the bottom line for us because the, you know that putting intermodal volumes into the numbers that we have before you puts relatively lower per unit numbers, and as we are -- I would look at it, if I were pointing someone in the right direction, to see whether we continue to have the ability to improve our margins.

At the same time we increased the mix of intermodal in our business to the extent we can do that, then we're achieving at least one of our management objectives.

Yes, sir.

Excuse me.

Thanks, David.

You mentioned that the mining permits are one of the constraints going forward for eastern coal.

I've been reading an article recently stating that the coal companies are having problems hiring enough coal miners.

What sort of constraints does that present to you?

Well, I think we seeing production constraints and particularly in the eastern Appalachian mines and you see that reflected in our numbers.

In some ways, some cases that produces longer hauls for us, but naturally we, we have an interest in as much production because in the, in the Appalachian mines as possible, so we do everything we can working with our coal customers to encourage the permitting and finding people is an issue for all of us, mines included, so all we can do is be sure that we provide the best transportation and give as much encouragement to our customers and I think they are all looking as hard as they can for production and our objective is to make sure when it gets out of the ground we get it delivered as rapidly as possible.

That's just the way we approach that business and we -- I've learned over the years you have to take the coal business as it comes and just be prepared to handle it.

That's all we can do.

Yes, sir.

Dave, I just want to clarify, you said a six in front of the operating ratio, is that correct?

Beg your pardon?

You said a six in front of that?

That's a wonderful thought.

I don't want to anybody to look for 5 percentage points improvement in that every quarter, and, you know, you know that.

But we will continue -- you know, we don't know any more than we did years ago what the right operating ratio for us is, but we do think that we can continue to drive for improvement.

You know, we've made no secrets that that's a core objective of ours and we will continue to do so.

Just two further clarifications.

The gain, the Conrail gain, is that an other income below the operating income line?

I just wanted to clarify that.

And then secondly, you talked a bit about the backlog at the ports.

We're seeing a tremendous kind of second peak season going on right now at the west coast ports.

What kind of capacity do the eastern ports have and where are most of these volumes?

You said we're seeing a lot of scaling at some of the east coast parts from the straight to Asia business.

Where are you particularly seeing that scale?

Thanks.

I'll answer the first, Don, and you get ready to jump up on the second.

The answer to that is, yea, the Conrail gain is in the other, is in the other income.

That's why we are so careful to break those two out because that is, that's the 13 cents that's below there and of course obviously very strong quarter when you pull that out as well, so we have done that and that is not reflected in the operating ratio, the operating ratio improvement.

It's -- what it is is improvement in revenues and operating expenses, better mix of 16% increase in revenues and 8% increase in expenses is what does that.

The import capacity, Don, do you want to say something about that?

A challenge.

Wal-Mart effect back at the shop, urge coming from the west coast ports.

Two factors there.

One, I mentioned in the remarks that focusing on the all water service to the east coast ports, port in Norfolk and others, Baltimore, et cetera, that certainly helped with that.

Certainly the surge that's awaiting to come through the west coast ports, we don't see that as a major capacity issue with respect to the east in terms of our terminals, and I, I think, too, that when you look at the numbers and you see the increases in international that we had earlier in the summer, there was some ship ahead, you know, in anticipation of the peak in October and November as well.

So all water service to the east and the ship ahead that took place and we have capacity at our terminals to take what the western carriers are bringing us as they trans load that from the vessels.

So we don't really see a major problem there as it comes to us.

And we do think over time that we will see some of this all water moving into the eastern ports where we have capacity along with our partners in the port business to handle that and we do -- we are anticipating that we will see more and more of that as volumes increase in this business.

I think Don, maybe you could help us with this one.

We see some of the rails and I hate to use the word demarketing, but, you know, kind of pulling down those low yielding commodity lanes where you're cluttering up the railroad at the expense of higher yielding commodity lanes.

Can you talk a little bit about your mix management so you keep capacity available for the best yielding commodity lanes?

Not much into this demarketing business, are we, Don?

I don't remember demarketing.

I haven't used that term, I know.

You know, all freight is not equal, obviously, and we look at the markets as being different.

We look at the value of the freight that we transport being different and that's why we differentially price.

So in our portfolio of business, we see different values, but generally what we're seeing is that that value proposition continues to rise because our transportation bogey is highway with respect to the economics and frankly, we see that bogey rising and then we see the opportunity to take our individual commodity yield up closer to that as we continue to work on service and we continue to have capacity to add business.

So we're really not focused on deemphasizing business.

We're focused on bringing business on at the right value proposition.

We're trying to maintain the high value and services is the key component in this, maintaining the high value of our product, and as we do that we make that available to people that want to use it at a price that we think is a faired all prices are market driven.

So we have to be sure that we're providing something that really does have value in order to be paid for it appropriately and that's our -- we have made no secret over time, over the -- I've been talking about this over the last five or six years.

As you know, this is our core objective, is to produce a high value product and maintain improvement on that.

Yes, sir, back here.

With this voracious demand that we have here, is there a need--

Voracious sounds somehow bad.

It's almost like a commodity party going on out there.

I just want to know if, is there a need to increase hiring on your behalf?

Do you see -- how many train and engine employees do you have currently?

Any?

Yeah, we are hiring train and engine employees pretty much throughout the system.

Steve, I don't remember the number.

Do you, Mark, or Steve?

About -- we will probably hire about 1,500 train and engine employees, Steve and Mark Manion coached me, and we are out looking for it because our business requires that we have people who, people to move it.

That -- you saw the compensation numbers, which we broke out for you and you see the effect of that in there.

We, at the same time have tried to respond by managing very tightly on our, on our administrative, on the administrative side and we took some actions last year that we are benefiting from this year on that.

In that respect, we try to balance that.

But we need -- no question, we need people to handle the trains and that's our business and we're -- we try to maintain that.

Steve wants to say one thing about that.

I'm going to beat a dead horse a little bit.

If you'll recall, we put into place our thoroughbred operating plan almost two years ago and in that plan we built capacity as we have enjoyed the increases in volumes, we have begun to fill that capacity.

That let us utilize the employee base that we had without having to exponentially add people to the process.

We still have capacity in the top plan.

It depends on the mix of business, the length of haul, the service requirements of the customers desire when they bring the business to us, but at the same time, we're mindful of the fact that we do need to add resources as we continue and we'll make those adjustments, as I said before as we go along and try to stay ahead of the curve.

Very patient.

Any others?

Well, thank you for sticking with us.

I'll just say this is an exciting time to be in, in this business and we're all, we're all challenged by it and we look forward to seeing you again in another quarter, hopefully with good results.

Thank you.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnects your lines at this time and have a wonderful day.