Norfolk Southern Corp (NSC) 2005 Q3 法說會逐字稿

I'm David Goode, Chairman and Chief Executive Officer of Norfolk Southern, at least for a few more days.

It's my privilege to welcome you to our third quarter 2005 analyst meeting.

And I'd like to welcome those who are listening by telephone today.

And as always, I'm encouraged to remind the people here to use the microphones so that the listeners can hear and identify who's asking questions and talking.

I'm also asked to remind everyone that the slides of the presenters are available on the internet for your convenience on our website in the Investors section.

And, as usual, transcripts of the meetings will be available on our website and on request from our Corporate Communications department.

Now, I am asked to remind you, as usual, that any forward-looking statements made during the course of this represent our best good faith judgment as to what may occur in the future.

And the actual results may differ materially from those projected and depend on a number of variables, some of which may be outside the control of the Company.

And you are referred to our annual report in form 10-Q filed with the SEC for a discussion of all of those.

And, keep in mind that all references to reported results, excluding adjustments, i.e. non-GAAP numbers, have been reconciled and will be available for you on our website.

Now, let me make a few introductions.

We have with us today several members of our senior management team, including President Wick Moorman, who as you all know will become CEO on the first of November.

Our Vice Chairman, Hank Wolf, Chief Financial Officer, is here.

Ike Prillaman and Steve Tobias could not join us today.

However, Don Seale, Executive Vice President Sales and Marketing, is here.

You'll hear from him in a minute, as well as Mark Manion, Executive Vice President of Operations, who is sitting right there.

We also have Bob Fort in the back of the room, Vice President Corporate Communications;

Bill Galanko, our Vice President Financial Planning is here;

Rob Kesler, Vice President Taxes;

Marta Stewart, Vice President and Controller;

Leanne Marilley, our Director of Investor Relations, and I hope all of you know; and Debbie Malbon, Hank Wolf's Assistant, is somewhere close by, in the back of the room there.

Now, let me get -- with introductions out of the way, let me get to business.

I'm pleased today to be reporting what was a very strong quarter for us.

It's strong on revenues and it's strong on income.

It could have been even stronger but for the unusual September storms which disrupted traffic and pressured expenses.

We also had unanticipated costs on the legal side, which you'll hear about.

Naturally, the high fuel prices, which spiked even higher late in the quarter.

However, with all of the challenges, we have been able to maintain service for our customers including in and through New Orleans.

And to handle what are historically high volumes of business safely and efficiently and with good returns.

So in spite of a lot of head winds this quarter, we posted very strong results.

And like the Starship Enterprise, our volumes and revenues are going where we have not gone before but we are enjoying the trip.

I'll give you some headlines and others will amplify them a lot.

I think the basic headlines are first, our revenues were up a strong 16% to a record 2.2 billion for the quarter, on record-setting 2 million plus units.

All three of our business segments were good, as you will see.

Intermodal posted another all-time high, up 17% in revenues.

Coal was up 22%, close to its high, as well.

Merchandise was the lowest at only 13% increase.

So that's the kind of quarter it was.

Don will enjoy breaking all of this down for you, and you can undoubtedly understand why Ike is in France.

With all this business, our expenses were up as well.

Hank will give you full details of this.

Our operating ratio was 75.5%, very respectable considering it included several unusual items.

For example, hurricane costs and increased casualty claims in September, which represented 1 full point on the operating ratio.

Year-over-year we're seeing continuing reduction in our operating ratio and we expect continuing progress on that.

Let me emphasize that margin improvement remains the high priority as we grow this business.

That goes for me and I'm sure you'll hear it from Wick, as well.

Our income from real operations improved 13% and net income of $0.73 per diluted share was 28% higher than the comparable period last year, excluding the effects of the Conrail corporate reorganization which you may recall and will see in a minute, were reflected in this quarter last year.

In summary, and in short, this was an excellent quarter for Norfolk Southern.

It continues to show the positive structural change in our business, which we are convinced has legs to continue.

Our fourth quarter volumes to date continue to put us on track for a record year.

Operationally, we're improving our service steadily after the disruption caused by the hurricanes.

As you know, we restored service back to and through New Orleans in remarkable time, due to the extraordinary efforts of our people to rebuild the Lake Pontchartrain Bridge and restore our yards.

We continue to be very proud of the work our people did in that regard.

I think it was a thoroughbred effort in all respects.

Service is nowhere near where we want it at the moment and nowhere near where it will be, but our service is steadily improving and we are confident we're on an uptick, even as weather and other disruptions continue to occur.

So, on the whole, in spite of everything that's happening out there, we're seeing strong traffic levels continue into the fourth quarter.

I do not see any barriers to our service through the fall traffic peak and for end-of-year business.

Volumes in the quarter have picked up steadily and are running ahead of last year.

With decreasing hedges, fuel remains a very high factor on the cost side.

Even though our fuel surcharge program is effective and, importantly, we continue to benefit from pricing that reflects how attractive good rail service is when energy costs are high.

Our strategy for ending the year is to continue handling the high traffic volumes we're seeing efficiently to keep our service good and continue to attract more business at the strong value pricing we've been emphasizing.

The market is strong for our rail transport today and our top plan is working.

As service improves, costs will improve as well.

Now, I'm going to ask Hank Wolf to unfold the numbers for you in detail.

Then Don Seale will go into the details of our business levels.

And Wick, then, will talk about his plans to keep the operation leading the transportation business.

Mark Manion does not have prepared remarks, but he's here and will be happy to talk about operations.

All of us, of course, will be glad to take your questions in a minute.

Now I'll turn to Hank.

Thank you, David.

And good morning.

As David indicated, I'll be reviewing the financial results for the third quarter in detail.

Our railway operating revenues for the third quarter were 2.2 billion, up 298 million or 16%, and were the highest quarterly revenues in our history.

For the first nine months, railway operating revenues were a record 6.3 billion, an increase of 907 million or 17%.

Third quarter volumes were up 5%, driven by a 9% gain in intermodal units and a 6% gain in coal car loads.

And revenue per unit increased by 11%, reflecting increased fuel surcharges and higher rates.

So the increased volume and higher revenue per unit combined to produce a 16% increase in railway operating revenues.

For the first nine months, volume growth of 5% and a 12% increase in revenue per unit produced a 17% increase in railway operating revenues.

Don Seale will provide you with more details on our revenues in just a moment.

Railway operating expenses for the third quarter were 1.6 billion, up 239 million, or 17% compared with '04.

For the nine-month period, railway operating expenses were 4.7 billion, 624 million or 15% higher than '04.

The largest increase in railway operating expenses for the third quarter was in fuel costs, which rose $91 million, or 93%.

As you would expect, this rise was almost entirely due to higher prices, as the average price per gallon increased from $0.88 in the third quarter of '04 to $1.52 this year.

Consumption increased by only 3% on a 5% increase in traffic volumes.

The average price per gallon would have been $1.85, absent the benefit of the fuel hedges that we enjoyed during the quarter.

The fuel hedge benefit for the third quarter was just equal with last year, despite the fact that less than half as many gallons were hedged this year.

That's due to the recent price spike that we saw in diesel fuel prices.

However, we believe that we have reached an inflection point, which means that going forward, we expect our hedge benefit to decline compared to the prior year period.

As you can see, throughout this year, our hedge benefit has exceeded or equalled the prior year's benefit amount in dollars, even though the gallons hedged were significantly lower.

For the next three quarters, the gallons hedged continued to drop until our hedges are fully settled in the second quarter of '06.

The largest increase in operating expenses was in compensation benefits, which rose 59 million, that's the second largest increase in compensation and benefits, 59 million, or 10% compared with last year.

The increase in compensation and benefits expense was in part driven by increased T&E and mechanical hours that added $17 million, as we added more train and engine trainees and mechanical employees needed to overhaul locomotives and freight cars -- repair freight cars.

The increase in the price of Norfolk Southern stock, which climbed almost $10 or 31% during the quarter, added $17 million of stock-based compensation.

Increased wage rates added 12 million over last year.

Higher health and welfare benefit costs and lower pension income added another 11 million.

And other items added 2 million, including 1 million in hurricane relief grants that were made to employees in the affected areas.

This hurricane-related expense is not covered by our insurance.

And you'll find that, with the exception of this item, Hurricane Katrina related costs are reflected in the casualties and other claims line of our income statement.

Material services and rents rose by $51 million, or 12% in the third quarter.

Within this category, increased maintenance activities added 26 million and included $13 million of material costs for locomotive overhauls and freight car repairs.

Volume-related purchase services increased by 14 million, largely driven by increased intermodal volumes.

Equipment rents were up 3 million, primarily due to Conrail equipment leases, which were previously reported in the Conrail rents and services line.

As you saw, a number of increases in these categories are related to volume.

However, some of these increases can be tied to initiatives that we said we were undertaking in order to improve our service levels and position ourselves to capitalize on the growth opportunities that are available.

Two of these items are shown here.

Locomotive and freight car expenses and the training costs for T&E employees have steadily increased throughout the year.

We have increased the number of locomotive overhauls in an effort to reduce our bad order ratio and ensure locomotive availability for increased traffic volumes.

In addition, we increased our hiring and T&E training in order to assure adequate numbers of qualified train and engine employees to handle the increased volumes.

Also, we have increased some of our roadway maintenance activities to ensure safe operations and this has added almost $18 million to our material services and rents costs this year.

And while year-over-year increases have leveled, you should expect that these costs will continue, probably at current levels throughout 2006, assuming that we continue to see the strong traffic levels that we've experienced.

Depreciation expense increased by 45 million, or 30% over the same period last year.

But as you'll recall, this is principally due to the effect of the divisive reorganization of Conrail last year and you'll note that there is an off-setting reduction in Conrail rents and services.

Casualties and other claims were up 28 million or 90% for the quarter.

This increase was primarily due to an unfavorable jury verdict, resulting in a $16 million expense charge.

Expenses caused by Hurricane Katrina, higher insurance costs and loss and damage expenses each added $4 million.

Total estimated cost of the Hurricane are approximately 44 million, including about 30 million for reconstruction and replacement of destroyed assets.

The major costs in this estimate include the replacement of several miles of roadway, including our Lake Pontchartrain Bridge, the replacement of wayside signals, repairs to the Oliver Yard in New Orleans and Mobile Yard in Alabama.

And other items, including replacement of maintenance of weigh equipment, some minor lading damage and equipment damage, rerouting costs, loss of vehicles and computer equipment, and environmental cleanup, and the removal of more than 5,000 trees.

Our property insurance is expected to cover amounts in excess of our $12.5 million self-insured retention.

Since approximately one-third of the costs are expense items and two-thirds must be capitalized, our casualties and other claims expense line includes $4 million reflecting the percentage of the retention that relates to the expenses.

Other operating expenses were 13 million or 27% higher than last year, principally due to increased property taxes and higher sales and use taxes.

For the first nine months, railway operating expenses were up 624 million or 15%.

As in the case of the third quarter, the largest increase for the year was in diesel fuel expense.

With the price spike in the third quarter, our average price per gallon rose to $1.30 for the first nine months, compared with $0.86 last year.

Without the benefit of the fuel hedges, our average price per gallon for the first nine months would have been $1.62.

Our fuel hedges have produced $121 million in diesel fuel expense savings for the first nine months of the year.

The next largest increase was in material services and rents, which increased 179 million or 15%.

The same costs that impacted the quarterly increase again contributed to the year-to-date increase as well.

And included higher volume-related purchase services of 60 million, 59 million more in maintenance activities, including 39 million for locomotive and freight car materials, and higher equipment rents which were up 28 million.

I should also note that we are seeing increases in some material costs as a result of higher fuel and energy costs such as gasoline, lubricants and travel expense.

In addition, vendor costs and service provider charges have been increasing as these vendors and service providers pass on their higher energy costs.

For the first nine months, compensation and benefits expense was 177 million or 11% higher than last year.

The increase was a result of increased T&E and mechanical hours, which added 63 million.

Higher wage rates of 35 million, increased health and welfare benefits expense and lower pension income, which collectively added 29 million, increased stock-based compensation of 18 million, higher payroll taxes of 12 million and other miscellaneous items that collectively totaled $20 million.

As in the case of the quarter, there was an increase in depreciation expense and a corresponding decline in Conrail rents and services as a result of the Conrail divisive reorganization.

Casualties and other claims expense was 68 million, or 62% higher in the first nine months of '05.

This was driven primarily by the costs associated with the Graniteville accident in the first quarter, as well as the unfavorable jury verdict that we experienced in the third quarter.

Other expenses were up 22 million or 13%, again reflecting higher property taxes and sales and use taxes.

The railway operating ratio for the third quarter was 75.5% compared with 74.7% last year.

I would like to point out, however, that just two items, the unfavorable jury verdict and the expenses associated with Hurricane Katrina, together added a percentage point to the operating ratio this quarter.

For the first nine months the operating ratio was 75.7%, compared with 76.9% for the same period last year.

This represents an improvement of 1.2 percentage points over last year.

Third quarter income from railway operations was 528 million, up 59 million, or 13% compared with last year.

For the first nine months, income from railway operations was more than 1.5 billion, up 283 million or 23%.

Total other income and expense for the third quarter was an expense of 87 million, compared with an expense of 81 million last year.

Although the total change is small, there are several large variances within this category.

As you'll recall, the Conrail corporate reorganization occurred during the third quarter of '04 and resulted in a $53 million gain.

Conrail equity earnings were 12 million higher this year because prior to the Conrail reorganization, this was recorded in Conrail rents and services.

Therefore, last year's equity earnings in Conrail was reflected in other income, only for one month.

Interest income is 7 million higher, due to higher cash balances, as well as higher interest rates.

Coal royalties were up 3 million.

All other was an increase in income of 23 million, which is principally attributable to a favorable adjustment for deficiency interest, stemming from an IRS settlement of income tax liabilities for the taxable years 2000 and 2001.

Interest expense on debt was 2 million lower than last year, principally due to less debt.

For the nine-month period, total other income and expense was an expense of 330 million, compared with an expense of 313 million last year.

As noted earlier, the gain from the Conrail reorganization contributed $53 million to other income net last year that we don't have this year.

Expenses related to tax credit investments were 41 million higher than last year.

You'll recall that we made an investment in a synthetic fuel transaction in May of '04 that generates tax credits under section 29.

So our '04 results included only four months of expenses associated with this investment, compared with nine months this year.

Equity earnings in Conrail now reported in other income net added 26 million, interest income was up 18 million, gains on sales of properties and investments were 12 million higher and coal royalties were 10 million more than last year.

All other increased by 21 million as a result of several items, including the favorable adjustment for the income tax deficiency interest from the resolution of taxable years 2000 and 2001.

Interest expense on debt for the first nine months was 10 million higher than last year, principally due to the addition of interest on Conrail debt that was assumed as part of the Conrail reorganization.

Third quarter income before income taxes was 441 million, compared with 335 million last year, excluding the $53 million gain on the Conrail reorganization, a 32% increase.

For the first nine months income before income taxes was 1.2 billion, up 36% compared with 874 million last year.

Income taxes for the third quarter were 140 million, compared with 100 million last year.

The effective tax rate for this quarter was 31.7%, compared with 29.9% last year.

For first nine months, excluding last quarter's $96 million reduction for changes in Ohio tax laws, the provision for income taxes was 370 million, compared with 268 million in '04, and the effective tax rate was 31% compared with 30.7%.

As our taxable income increases, we are seeing our effective tax rate rise as all of the incremental income is taxed at the maximum statutory rate.

We expect our effective tax rate for the year to be comparable with the nine-month rate of 31%.

Third quarter net income was 301 million, which is 66 million, or 28%, higher than the 235 million earned last year, excluding the $53 million Conrail reorganization gain.

For the first nine months, net income was 823 million, compared with 606 million in '04, an increase of 217 million, or 36%, excluding the $96 million increase in income from the change in the Ohio tax law which took place in the second quarter, and also the $53 million gain on the Conrail reorganization in the third quarter of '04.

On the same basis, diluted earnings per share for the third quarter were $0.73, compared with $0.59 per share last year, a 24% increase.

For the first nine months, diluted earnings per share were $2.01, which was 31% above the $1.53 per share earned a year ago.

This slide reconciles our net income and earnings per share, excluding the effect of the Conrail reorganization in the third quarter of '04 and the Ohio tax legislation in the second quarter with our reported net income and earnings per share.

These reconciliations are posted on our website and are available for you there.

Reported net income for the third quarter was 301 million, or $0.73 per share, compared with 288 million, or $0.72 per share last year.

And for the nine-month period reported net income was 919 million, or $2.24 per diluted share, compared with 659 million, or $1.66 per share last year.

Thank you for your attention.

Now I'll turn the program over to Don Seale, who will give you an in-depth report on our revenues.

Thank you, Hank.

And good morning.

It is a pleasure to be back with you, if not a joy, as David indicated, to be able to report these results.

I am pleased to report that we once again achieved record results after a strong second quarter performance.

Our third quarter revenue grew 298 million, or 16% above third quarter 2004, to an all-time high of $2.155 billion.

This was the eighth consecutive -- or successive quarter of record revenues.

And it's noteworthy that this was achieved following second quarter revenue that included a $55 million adjustment for the settlement of the coal rate case.

With the exception of automotive and coal, all of our market groups achieved record quarterly revenues.

For the year-to-date, revenue of 6.27 billion was up 907 million, or 17%, over 2004.

And for the past 12 months our revenue is up 1.2 billion, or 17%.

With an improved service product and increased costs for the trucking industry, we're being able to market at a higher price point.

We've also continued to extend our coverage of fuel surcharges, which now stands at approximately 85% of total revenue.

This was also our highest volume quarter ever, up 87,000 units or 5% over 2004.

Intermodal, coal, metals and construction all achieved all-time high loadings.

Metals and construction volume exceeded the prior record set during the second quarter of 2000.

Our other merchandise sectors experienced some slowing during the quarter, as business fell 1% below last year.

Volumes were down due to market inventory adjustments, strong year-over-year comparisons and the impact of the storms in the Gulf.

For the nine months, strong volumes in the first half off-set the third quarter weakness and business is 1% ahead of last year.

For the quarter, strong intermodal and coal volumes more than offset variability in our car load sectors.

Coal volume reached nearly 452,000 units for the quarter, growing some 24,000 car loads, or 6%, over last year.

For the year, volume is up 4%.

This was the seventh consecutive quarter of year-over-year growth for our coal business.

And in intermodal, volume remains strong, reaching 827,000 units for the quarter, up 68,000 units or 9%, and up over 200,000 or 9%, for the year.

For 9 of the last 11 weeks, intermodal loadings have exceeded our record loading week during peak season last fall 2004.

Intermodal revenue reached 471 million for the quarter and 1.307 billion for the year.

Rate increases on both the domestic and international lines of business, along with increased fuel surcharges contributed to these gains.

For the quarter, revenue per unit increased by $37.

RPU was tempered by a 12% decline in higher revenue per unit trailer volume and strong growth in our international container business.

Length of haul declined compared to third quarter 2004, resulting from a decrease in eastbound transcontinental traffic in our domestic IMC business and an increase in shorter haul east coast all-water service.

For the nine months, revenue per unit was up $46 for our intermodal business.

Intermodal volume was up 9% for both the quarter and for the year- to-date.

Gains in international business continue to drive intermodal's growth.

Our international volume was up 16% for the quarter and 15% for the nine months, driven by strong international trade.

During the quarter, we saw a continuation of the trend of the first half of the year with more international traffic being discharged at east coast ports.

Our east coast port business was up 22%.

Our west coast port traffic was up 15.6%.

Our domestic volume was down 4% for the quarter and 1% for the year.

The continued reduction in transloading of west coast international freight into domestic trailers has resulted in some softness in this particular market.

But our truckload volumes remain strong with growth of 15% for the quarter and 12% for the year-to-date as our truckload customers continue to work closely with us on creating joint intermodal markets.

For the remainder of 2005, import and export activity is expected to remain at elevated levels, which will continue to drive international business.

In the domestic market, we're watching consumer spending closely in the wake of increased energy costs, as well as rising interest rates.

But overall, we remain optimistic about prospects in intermodal.

Now looking at coal, revenue reached 556 million for the quarter and 1.591 billion for the nine months, increasing 22% and 25%, respectively.

Including the adjustment in the second quarter for the rate case, this was our second highest quarter for coal revenue.

Revenue per car increased $164 or 16% for the quarter, principally due to rate increases on key utility contracts, new coke and metallurgical business and fuel surcharges.

Revenue per unit growth moderated compared to the first half of the year.

Higher-rated export volume declined by 4,500 car loads in the quarter, compared to the second quarter.

While shorter haul traffic increased by 10%.

This quarter's coal volume surpassed the quarterly volume record that we set in the fourth quarter 1999 just before Y2K.

Car loads increased nearly 11,000 car loads or 2.5%, compared to fourth quarter 1999, while tonnage is up 7%, as we continue to improve equipment capacity in our coal fleet.

Utility car loads increased 12% for the quarter and are running 6% ahead for the year-to-date, compared with 4% growth in electrical generation for the year.

Increased demand in our service area, record electrical generation and higher than normal oil and natural gas prices continue to drive these volumes.

Utility stockpiles have once again fallen below target, which should produce good volumes for us in the final quarter of 2005.

Our metallurgical coal volume increased 5% for the quarter and 9% for the year in the face of declining steel production.

The new Haverhill, Ohio coke plant came online in March receiving shipments of metallurgical coal and shipping outbound coke.

Growth in our domestic coal volume was at the expense of our export volume.

Export car loads declined 19% for the quarter and 5% for the nine months.

Lambert's Point shipments fell 28%, resulting from continued problems at Consol's Buchanan, Virginia mine, which will remain idle until early November.

In addition, the European steel market has slowed in recent months.

With less production the steel producers throttled back on coke production and used inventory on hand.

We believe this inventory overhang is almost depleted in Europe, which should boost fourth quarter volumes for export.

Now turning to our car load sector.

Revenues of 1.138 billion exceeded third quarter 2004 by 132 million, or 13%.

For the year-to-date, revenue reached 3.372 billion, up 374 million, or 12% over 2004.

As previously mentioned, all of our car load sectors produced record revenues, with the exception of automotive.

Revenue per car improved 14% for the quarter and 11% for the nine months due to rate increases, higher fuel surcharges and greater fuel surcharge coverage.

Revenue per car gains for our individual sectors ranged from 9% to 16%.

For the quarter, our car load sector faced difficult comparisons to strong traffic levels for third quarter last year.

And also record energy prices and production losses due to Katrina and Rita negatively impacted the industrial sector.

Our metals and construction business produced the only positive year-over-year car load comparison for the quarter, resulting in revenue of 252 million for the quarter.

A 6% increase in construction traffic offset weakness in steel volume as steel business was curtailed during the summer to reduce inventories.

Orders are now increasing in the steel business and are expected to continue through the fourth quarter, although not to the record levels set in 2004.

Paper revenue reached 202 million, up 14% for the quarter, and 586 million for the year.

Volumes for our paper markets continue to be strong.

The slight volume decline for the quarter was due to temporary softness for lumber and building products during the summer.

Automotive business comparisons improved for the quarter.

For the first half, volumes were down 4%, but for the third quarter units were essentially flat with last year.

Production declines at Ford and General Motors continued to impact volume comparisons and this trend should continue into the fourth quarter.

However, volume gains in our transplant business combined with improved yield and broader fuel surcharge coverage across the automotive business sector resulted in quarterly revenue of 229 million, up 9% over third quarter 2004.

Ag revenues of 203 million for the quarter and 596 million for the year was up 13% and 11%, respectively.

Growth in ethanol volumes accelerated by 27%, but could not offset a late start to this year's grain crop.

And chemicals revenue reached 252 million for the quarter and 728 million for the nine months.

Chemicals volume experienced its first year-over-year decline in seven quarters, falling 3,300 units below 2004.

We believe this decline is temporary due to storm-related disruption in petro-chemical production in the Gulf.

Now, looking ahead, as we all know, there are mixed economic signals for the fourth quarter.

Our outlook for coal, though, remains strong, as utility stockpiles are below target levels and the record cost of natural gas will make coal fire generation even more competitive.

In our intermodal market, we continue to see strong volumes during the peak and international trade is running 10 to 12% ahead of last year.

We do anticipate, however, difficult year-over-year comparisons for our car load sector.

Low tech industrial production growth was revised from pre-Katrina estimates of 4% to approximately 1.6%.

But on a more positive note, capital expenditures and orders for capital goods remain high as rebuilding in the Gulf ramps up.

This reconstruction should bode well for building materials and steel.

And we continue to monitor consumer confidence in the face of increased energy cost and recently reported inflationary pressures.

With all that said, freight transportation demand, however, remains relatively strong.

And we expect our balanced portfolio of business across the energy, industrial and consumer markets to continue to expand in the months ahead.

Thank you very much.

And now I'll turn it over to Wick.

Thank you, Don.

I'd like to just conclude today's program by spending a couple of minutes on our service performance in the third quarter.

And then talk for a minute or two about how we see things shaping up for the next few months.

First, I do want to underscore David's point that our third quarter results continue to demonstrate considerable positive momentum, particularly if you widen the lens and take a look at the longer-term view.

For the first nine months railway operating revenues were up a record 17%, all three general commodity groups reporting record-setting increases.

As you heard, year-to-date income from railway operations up 23%.

New record for net income increasing 36%.

I think most importantly, our operating ratio for the first nine months improved to 75.7%, as compared to 76.9% for the prior year.

In the third quarter, we were able to maintain stable operations, which I think is particularly notable in that, as you heard, we moved a record 2 million loads, including a record 452,000 car loads of coal, while we faced a number of operating challenges.

And if you look a little more closely at our operating metrics, train speed and terminal dwell, in particular, and to a lesser extent cars online, I think they illustrate a couple of important points.

The first is that as we have already discussed with you, we finished rolling out our new TOP II plan by mid-August.

And we saw a steady improvement in all of our metrics as a result.

Clear confirmation, we think, that the plan was achieving results even as we saw higher and higher year-over-year volumes.

Then came the storms, Katrina and Rita.

They've been followed by some other, what I would call lesser operating issues, but operating issues nonetheless.

This last weekend, in fact, Steve Tobias was muttering about the effects of the full moon.

So now that that's passed, we expect things to get better.

Our service has remained at reasonable levels, but as you've seen, we've experienced some temporary degradation in our performance metrics.

Those metrics are all stable now and beginning to track in the right direction.

And we expect to see continued improvement in the fourth quarter, subject as always, to the uncertainties of winter weather.

I think there are a couple of lessons to be drawn from all of this.

The first is that we have been able to maintain the fluidity of our network in the face of what I think are some significant challenges.

And that's a testament not only to our Thoroughbred Operating Plan, which we talk a lot about and all of the associated management systems, but also clearly to all of our people whose talent and dedication helped us to maintain service levels while the network has been restored.

The second lesson I think, from the service standpoint from the quarter, is that while we had the capacity to efficiently handle even the traffic volumes that we're now seeing and, in fact, more volume, it now takes us longer to recover from a network disruption than it did when volumes were lower.

And we're working very hard to provide a little more resiliency to our network.

TOP II does have additional capacity built in.

And that's paid off in the quarter as we encountered some of these disruptions.

In addition, we continue to make and will continue to make targeted investments in all of the drivers of capacity.

As I mentioned last time we met, we are taking delivery this quarter of more locomotives.

We expect to take in about 85 new locomotives this quarter.

As Hank showed you, we're continuing to make investments in people and in locomotives and car programs and maintenance, so that we can maintain and improve our operating and service standards.

We'll continue to take steps like this and more to improve customer service and drive more efficiency out of our network.

We remain committed to the concept that by improving service, we can continue to generate increased business and improve our margins.

Looking ahead, Don mentioned, we do believe that business trends are favorable for most of our business segments.

We're prepared for that.

However, our belief remains that even if economic conditions begin to soften, a lot of the volume expansion that you've seen and we've talked about is structural in nature.

And we're not as exposed to shifts in the business cycle as we once were.

And additionally, as Don mentioned, we have a balanced portfolio which greatly reduces our dependence on any single segment of the economy.

We're confident that we can continue to drive demand for our service products.

We are very confident that we can also achieve additional efficiencies on the operation side and the cost side.

We remain focused, not only on top line growth, but on contribution as measured at higher operating ratio.

And we are committed to continue to improve the operating ratio.

And at that, I'll turn it over to David for questions.

As usual, we've given you a lot of information.

Hi.

Tom Wadewitz from J.P. Morgan.

A question for you on the demand and the pricing side.

It sounds like you're reasonably optimistic on the economy, or you haven't seen signs of softening yet.

On the coal and intermodal side, if you looked at 2006, you think that it's reasonable to expect some similar strong growth trends in those two segments, given what you see today in terms of volumes?

I would say that generally speaking on the coal side, we don't see any sign that that's letting up at all.

On the contrary, we don't know what energy prices are going to do anymore than anybody else.

I'd be very surprised to see them decline significantly over the next year.

That given the case, we expect to see continuing strong utility demand.

I think the production -- there have been production limitations this year.

We see those moderating as time goes on.

I think that we are certainly looking for and planning on very strong continued growth on the coal side.

Intermodal, you saw the kind of continuing numbers.

Naturally some of the intermodal businesses -- I think of that as consumer-driven business.

So we don't know where the economy is going.

But the shifts that you're seeing in the export business we don't see slackening at all.

The trend of movement towards the east coast ports is one that we think is structural, as well.

The truckload -- I think the conversion of business that you see reflected in the growth of the truckload is a significant structural change.

I think that everything we see indicates that that's going to continue.

Don, do you want to amplify that?

So -- we're -- we remain bullish on the continued growth in those sectors.

In terms of the pricing up of business, it seems we've had it, perhaps beginning of '04 and then through '05, a very strong rail pricing environment.

Can you give any kind of a rough sense?

Is it reasonable to think about maybe 20% of the portfolio, 25% that you haven't touched in that strong rail pricing environment that you would still be able to price up in say, '06 or '07?

Don, do you want to comment on that?

Tom, on a given year, generally speaking, we have about a third of our business that comes up for repricing opportunity.

As you know, about two-thirds of our business is under contract.

But the anniversary dates of that business generally gets retreated about one-third each year.

So, there's additional pricing opportunities ahead.

I think -- we price to the market.

We look at the market with continued energy costs, trucking costs being what they are.

We see a fairly favorable environment.

But we're keeping our eye firmly on the market when we say that.

But using those numbers, it's fair to think there's some piece of business that's meaningful that you really haven't touched in '04 or '05 on the contract side?

We have some large utility coal contracts that we're in negotiations on.

We've got some rather large intermodal contracts that we're also in negotiations on.

So, to answer your question, those are significant opportunities for '06.

Okay.

And then my last one.

Don, since you're up there -- on intermodal mix, I was a little bit confused by the comment on -- you said something about trailers affecting the yield number negatively but the truckload numbers were still up pretty meaningfully.

Can you give a little further color on that?

Couple of comments on that.

One is, as we've seen freight migrate from southern California up the coast on the west coast, and our business was up 15.5% for that particular business segment.

As it goes to Seattle, Tacoma, there's less transloading into 53-foot trailers.

The IMC business is also shifting from highway trailers to boxes, to containers -- domestic containers.

In the double-stack world, there's a revenue per unit differential in the container versus the trailer.

The margins are quite good in the containers.

So in terms of the RPU, it's a decline, but we're quite happy with the margin, the yield on the container conversion.

So, as IMCs convert from highway trailers to containers, and also there's less transloading taking place on the west coast into 53-foot highway trailers or rail trailers.

That's driving that RPU.

So the IMC effect was overwhelmed, the truckload specific effect?

Right.

That's right.

Okay.

Great.

Thank you.

Great.

Hi.

It's [Tony Atch].

Don, while you're there, or any of you guys.

Related to that question Tom just asked -- as you reprice the business over time -- just wanted to know if you would comment on the correlation between price increases and service levels?

That sounds like a loaded question, Tony.

Obviously from our perspective, there is a strong correlation to service, the product of our service, or the quality of our service product to our customers and being able to price to that service in the market place.

So we find that there's a direct correlation.

And it's something that we've worked very hard with respect to TOP, TOP II, our intermodal service product, our coal service product.

We continue to invest and really move the needle on that to make it better.

Because we think it's a higher value product as we do that.

You all know that that equation between improving service and improving the value of our products and therefore our ability to place it, has been a linch pin of the strategy that we've operated the Company on, really over the last several years.

And we think that that really has been a successful strategy and the numbers -- the good numbers you're seeing are a reflection of that.

I don't think Wick has any plans to throw that strategy out the window.

And we're going to continue to improve our product because we believe by the -- simply by doing that, it's a more valuable product.

We're going to price it accordingly.

We'll see what the market tells us; all of these prices are market prices.

The only thing we know is to make our product more valuable and therefore priced better.

Ken Hoexter from Merrill Lynch.

I feel we need to make Hank get out of his chair.

So on CapEx, you didn't actually go over some of the capital numbers.

I did some quick math.

Looks like your CapEx was about $220 million.

If that's right?

Hank would be very unhappy if he didn't get to talk about capital expenditures.

That seems a little low, if that is right.

Is there -- did you have other -- ?

Obviously, the -- I expect that the storms that we saw during the course of the quarter had some impact on that.

Right now, our projection is that the CapEx probably for the year will be somewhere between $1.1 and $1 billion, probably right in the midpoint of that.

Somewhere around $1.05 billion for the year.

Okay.

Now looking at -- it seemed like your fleet's getting a little older because you're adding new fleet, but you're not retiring some of the older ones.

So trying to keep them on to handle the increased business.

You talked a little bit about a lot more overhauls and additional materials required.

Is that a trend that we're going to see over the next few years, keeping up the increased -- ?

I think as I indicated, that the material costs were for locomotive overhauls, which I think I indicated you would see through 2006 as we try to get our bad order ratio down and make those units available to the operations.

And we will continue to make the freight car repairs that we need to keep the fleet in good operating condition.

We're right now in the process of trying to formulate a capital budget for 2006.

As we do that, obviously, we're mindful of the aging of the fleet and will be as we go forward beyond 2006.

Let me add one thing to that.

Not only are we committed to take locomotives this quarter, but as you know, we've announced that we're going to take a significant traunch of new locomotives next year in the first half of the year.

Part of our strategy there is to go ahead and retire some of our older units which are less reliable and which we think are beyond the point of effectively overhauling for more life.

The second part of that strategy is to reduce the number of locomotives we have on short-term lease from third-party suppliers.

We, like every other major carrier that I know of, are leasing some power right now.

We'd like to get rid of some of that leased power, as well.

We think that between the actions that we're talking about of increasing the overhauls on our current fleet -- and we overhaul typically, depending on the manufacturer, at about the eighth or ninth year of a unit's life.

And so with the overhauls, our ability to retire some of the older units and get rid of some of the leased units, we are expecting that we'll see a significant improvement in the reliability and availability of our locomotive fleet.

We've got a lot of work going on on the efficiency of our locomotive fleet, as you're hearing.

Any chance, or has there been discussion on selling the coal field?

No.

Then on the IRS, Hank, you noticed on other charges there was a -- it looked like a positive gain in other income.

Is that -- was that a one-time kind of benefit?

Or is there anything pending, you said, from '90-'91 -- I'm sorry, from 2000-2001?

Is there anything going on from '02-'05?

Obviously, as we go forward, there will be subsequent audits for years after 2001.

But the adjustments that were made were made simply to reflect the outcome of the 2000-2001 audit.

We're in the process of starting the 2002-2003 audit.

That cycle is likely to take 18 months or perhaps even longer.

Just a last question for Hank.

With tax rate increasing, does that mean that synthetic fuel leases have been used up?

Or is that just you're saying, as the upper other total income is going up -- ?

The latter.

As we are adding marginal income, that marginal income is being added at the top marginal rate.

That's what's dragging or pulling the effective rate up very, very gradually.

Still well below -- at 31%, still well below the top rate.

That's one of those good news-bad news things, Ken.

As income levels rise, the taxes rise.

Price of living in a good society.

It's Rick Paterson from UBS.

This one is for Don.

Don, two of your larger truckload intermodal customers were JB Hunt and Snyder.

Are you in talks with any other [inaudible] that could meaningful business onto the network at any point?

Rick, could you repeat the last part of the question?

I didn't catch the last part.

Sure.

I think [inaudible] customers JB Hunt and Snyder on the truckload IM side.

Are you in any talks with any other big guys, like a Swift for example, that could bring on meaningful volumes in the future?

We're having discussions with all of the truckload carriers.

U.S.

Express being another example of a carrier that's obviously beginning to deploy a structural strategy change that looks at intermodal as a bigger portfolio of their service product.

Swift, with their purchase of domestic containers, we're having discussions with them as well.

So, we see opportunities, in terms of partnering with all of the truckload carriers.

It comes a little bit back to what we were talking about with the service product, reliability of service and being able to do that consistently.

I think you were renegotiating your Hunt contract.

Has that been done?

I would rather not comment on a specific negotiation, Rick, if I may not.

Fair enough.

Last one for David and probably Wick.

Do you think you'll earn the cost to capital by 2008?

Do you want to respond to that?

Say yes and I'll ask if it's for 2007.

Our goal is to earn our cost to capital every year.

As I like to say, we may not be earning it yet, but at least we're close enough to have an argument about what it really is. 2008?

I would hope so.

Oh, it was 2008.

I would be very surprised --

Yes.

We think we're getting close.

And we would fully expect to be there, I would hope, by then -- barring the economy or something untoward.

I think we'd rather not predict year-by-year, but we're eagerly awaiting the end of the year and we'll let results speak for themselves.

Thank you.

Yes, Ken?

Just one quick question for Don.

Ag rates were up pretty handily.

Was there something driving that, other than just the typical fuel surcharge discussion?

Was there kind of a mixed shift going on there?

There is a mix effect, Ken, with respect to ag.

Ethanol traffic was up 27%.

We continue to see that market really develop.

I think we're just beginning to see the development of it.

But also, our southeastern feed mills continue to ramp up.

That's long haul grain that's moving from the midwest, cycling into the southeast.

We've got new mills that are reaching higher production levels.

So it's a mixed effect.

But I think you're also seeing the basic grain market continue to grow for us on a ratable basis, in terms of midwest to southeast.

Just a last question.

I figure I'm going to ask it anyway.

Can you break down the 11% yield between rates -- pure rates and fuel surcharges?

If you're not going to do that, another one of your peers gave us kind of a clue as to directionally what fuel surcharge revenues were this year versus a year ago for the entire company.

Can you kind of comment on that?

When we look at the pricing equation, we look at price and look at fuel surcharge.

And we've talked about the marketplace in terms of being able to drive both of those.

We look at both of those components that you mentioned as market drivers.

So it's a competitive issue for us with respect to getting into those numbers.

And because we're negotiating, Ken, we would rather not get into that particular data.

Marta knows what the 10-Q is going to say.

Do you want to -- ?

I can give you a little bit more information with respect to the RPU, not breaking it out in terms of each component.

For the third quarter, when you would look at fuel, approximately 50% of the RPU increase was attributable to the fuel surcharge.

Yes.

Who's got the microphone?

Just one follow-up for you on capacity.

If you look at 2006 -- and let's say we have pretty good coal, pretty good intermodal volumes and so forth, where do you think the tightness on capacity is?

Are there track issues where you might be a little bit tight on some of the coal lines?

Or is it still really a locomotive issue that is really the tightest point of capacity for you?

Any thoughts on those?

I'll let Mark comment, too.

I would say that when we look at capacity right now, locomotives are -- become an issue, particularly when we have a network disruption.

We think we're handling that in the way I outlined.

When we look at the network itself, I think that it's clear that the most constrained parts of our railroad are probably the region down around Atlanta up towards Chattanooga.

We have made some improvements and we have some more in the budget for next year there.

We think we have the right plans to address those.

We feel pretty good about capacity right now, in terms of our ability to handle the business we see coming.

As I mentioned earlier, I think the issue for us now is making sure that we build in a little more of a recovery capability.

Is that fair, Mark?

That's fair.

I would just add -- I think it's important to note that the fundamentals are fully in place within the operation.

When I say that -- Wick has already talked about TOP II.

It was really refreshing.

Following the midsummer, when we really started to get a ramp-up of volume of business, TOP II just absolutely absorbed that business.

And then beyond that, if you look at the fact that our cars online are, even in the face of these volumes that have continued to ramp now for two full years, our cars online are at historically low levels.

That's pretty good.

That's a pretty good testament to being able to handle the volume.

And we feel particularly good right now because, as we're going through pretty heavy business and on into the fall, we've got more locomotives.

We've got significantly bigger crew base than what we did at this time last year.

And on top of that, we, like Wick said, we're continuing to look forward to more locomotives coming and more of these people coming out of training and being available to crew trains.

Just generally speaking, I don't think you all should underestimate the disruptions that occurred in the Gulf Coast segment in the whole as a result of those two hurricanes.

They were really significant service disruptions and changes in the way business flowed.

And those are continuing even today as we in CSX work together to deal with a lot of unusual traffic movement situations.

And the thing that really pleased us was the ability of our network to absorb those changes and the ability of Mark's people to make them on the fly and keep business moving late in the quarter.

As those that continued through the early part of the fourth quarter -- the network -- our network is showing a lot of capacity to absorb these changes and operate not at the efficiency levels that we expect to.

And we expect to continue to improve.

But that's pretty darn good efficiency levels.

So there's a lot of strength in this system.

Which means, to us, that there's a lot of ability to grow in this system without impairing our ability to earn that cost of capital that you talked about.

So I think that that's why we feel so optimistic about the structural changes that have been made, not only in our system but in the rail business as a whole.

Thank you.

Any other questions?

You've been very patient.

I know you got other things to do today.

Well, thank you for being with us.

We look forward to being with you in January to report another good quarter and a great year.

Thank you.