Norfolk Southern Corp (NSC) 2006 Q2 法說會逐字稿

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  • - President, CEO

  • Good morning, ladies and gentlemen.

  • I am Wick Moorman, Chairman, President, and Chief Executive Officer of Norfolk Southern Corporation.

  • It is my privilege to welcome you to our second quarter 2006 Analyst Meeting.

  • I would like to take a moment to welcome those who are listening by telephone, and can only imagine the scene in here.

  • I also would encourage all of you here today when speaking, to take a microphone and please identify yourself, so the listeners who are participating on the call can hear and identify you.

  • I would remind both the listeners and the Internet participants, that the slides of the presenters are available for your convenience on our website in the Investors section.

  • As usual, transcripts of the meeting will be posted on our website and available upon request in a few weeks from our Corporate Communications department.

  • 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 in the future.

  • The actual results may differ materially from those projected.

  • That means we may be wrong, and will depend on a number of variables, some of which may be outside of the control of the Company.

  • Please refer to our Annual Report filed with the SEC for a discussion of all of those variables.

  • Additionally, keep in mind that all references to reported results excluding certain adjustments, have been reconciled on our website.

  • We have with us today several members of our management team, including our Vice Chairmen, Hank Wolf, Chief Financial Officer, and Steve Tobias, our Chief Operating Officer.

  • We're also joined by Don Seale, our Executive Vice President and Chief Marketing Officer.

  • Jim Squires, Senior Vice President of Financial Planning, Bob Fort, Vice President, Corporate Communications, Rob Kessler, Vice President Taxation, Marta Stewart, Vice President and Controller, who is always ready to answer those difficult accounting questions, Leanne Marilley, Director, Investor Relations, and Debbie Malban, Hank Wolf's Assistant.

  • I am pleased to report Norfolk Southern produced record revenues and income from railway operations in the second quarter, reflecting the continuing strength of the market for our transportation product, as well as our sustained focus on providing a higher-value service product.

  • Demand for rail transportation continues to grow in most sectors of our business, and our second quarter results reflect strong volume growth, and an improved operating ratio.

  • Second quarter railway operating revenues of 2.4 billion established an all-time record for Norfolk Southern, up 11%.

  • We reported our highest ever income from railway operations, $677 million, an increase of 14% over last year.

  • Particularly noteworthy was our second quarter operating ratio of 71.7%, which was the lowest since the Conrail transaction, and 0.8% better than the second quarter a year ago.

  • There were several factors which affected our net income for the quarter, particularly with regard to year-over-year comparisons, all of which Hank will review.

  • In particular, you will recall that the results in the second quarter of 2005, benefited from the favorable impact resulting from Ohio enacted tax legislation, as well as the settlement of two coal rate cases, which increased diluted earnings per share by $0.23 and $0.06 respectively.

  • Our second quarter net income this year of $375 million, or $0.89 per diluted share, was 23% higher than the $304 million, or $0.75 per diluted share, which we earned in the same period of last year excluding those two items.

  • This was clearly a very solid quarter for our Company, and a continuation of the results that we've been seeing since late 2003.

  • Our second quarter results were again driven by our ability to handle continuing high volumes of business, with consistent and reliable service levels.

  • Our key operating metrics held steady or improved, in spite of the service disruptions caused by the flooding in the Northeast during the second half of June, and while at the same time we handled 4% more volume, or approximately 77,000 additional units in the quarter.

  • Year-to-date volume was up by some 171,000 car loads, and in fact we set a record in May for total coal volume, which reached 16.5 million tons, up 8.7% compared with May of the prior year.

  • This monthly record eclipses the previous record set in August of 2005 by almost 2%.

  • For the first six months of 2006 we also reported a number of financial milestones, railway operating revenues were a record $4.7 billion, up 14% compared with the first half of last year.

  • Income from railway operations was a record, up 23% over last year, net income was a record $680 million, or $1.61 per diluted share, an increase of 10% compared with the same period of 2005.

  • Our six-month operating ratio of 73.8% improved 2 full percentage points, compared with the same period a year earlier, and was the lowest since the integration of Conrail.

  • At the same time our volumes were growing, our operating performance enabled us to continue our value pricing model and improve our yields.

  • We remain convinced that by continuing to improve our service levels, we can continue to grow volumes and improve margins, and that's our #1 strategic priority.

  • To help us do so, as you've heard from me before, we're investing in the network.

  • We're continuing to hire train and engine service personnel, although our hiring program for 2006, while it is stable, is not quite as aggressive as last year.

  • We're continuing our locomotive and freight car overhaul programs.

  • We also have a number of targeted construction projects underway, to alleviate specific constraints across the network, and also at the same time we're pursuing several performance enhancing technology initiatives, which you've heard us talk about, in addition, including operating plan developer, unified train control system, Optimized train control and leader, and I will tell you that combined, these systems which focus on dispatching train control and train handling, will redefine the way we operate the railroad.

  • The bottom line on all of this is that our current success is in many ways is directly related to investments made in past years.

  • We continue to manage with a long-term perspective.

  • We remain generally optimistic about the health of the industrial economy, and we've been watching car loadings carefully through July.

  • Thus far our volumes have continued to demonstrate traction, albeit with some continued weakness in Autos and Chemicals, as you will see in Don's presentation.

  • While I always caution that my crystal ball is often quite cloudy, our current thinking is that volume growth in the second half of the year will continue to track along at about our current levels.

  • Clearly we also remain committed to our value based pricing, as we believe that our service efficiency gives us a competitive edge, and a more valuable product in the marketplace.

  • Obviously we have some challenges ahead as well, including cost pressures in the form of increased wages, increased health and welfare benefits for our employees, rising diesel fuel prices, and the final phase-out of our fuel hedging program.

  • Additionally, the locomotive, freight car and our maintenance programs I mentioned will continue to be reflected in our expenses.

  • As we approach peak season, we're confident that our improved operating efficiency, along with the investments we continue to make in the network, will position us to maintain our profitability and improve our service levels, and reaffirm our formula for success going forward.

  • As a further indication that Norfolk Southern is on the right track, our Board increased our dividend again yesterday as you all saw, in addition we've been repurchasing shares under the program we announced last November, and through the first six months of the year, we purchased approximately 3.6 million shares at a total cost of $187 million.

  • I am confident that the remainder of the year will continue to build on this strong quarter, as we move into the balance of the year we will continue to leverage our operating momentum to improve our service quality, pursue new business, and pursue margin improvement opportunities.

  • Now I will turn it over to Hank to review our numbers, and Don will then tell you about the specifics of our markets.

  • Steve does not have any prepared remarks today but will be happy to talk about operations in the Q&A, and all of us will be available to take questions after the presentation.

  • Hank.

  • - Vice Chairman, CFO

  • Thank you, Wick, and good morning.

  • Our second quarter and year-to-date financial results set new records for railway operating revenues, and income from railway operations.

  • In addition, our results for the first six months established a new record for net income and earnings per share.

  • As you may recall, in the second quarter of '05, we recognized income from a change in the Ohio tax laws that added $96 million, or $0.23 per share, to our reported earnings.

  • In addition, we reached settlement with two utility companies, which resolved their cases before the Service Transportation Board.

  • These settlements added $24 million of net income, or $0.06 per share, and as I conclude my remarks this morning, I would like to provide you with comparisons that exclude these two items.

  • Let me turn to our second quarter and first half year results.

  • Railway operating revenues for the second quarter were a record 2.4 billion, up 238 million, or 11% compared with last year.

  • For the first six months railway operating revenues were a record 4.7 billion, an increase of 580 million, or 14%.

  • Second quarter volume rose by 77,000 units, or 4%, compared with last year, driven by a 59,000, or 8% increase in Intermodal units.

  • In addition, the average revenue per unit increased by 7% reflecting increased fuel surcharges and higher rates, which coupled with the 4% increase in volumes, produced an 11% increase in operating revenues.

  • I should note that the 11% improvement in operating revenues, represents a more difficult comparison, since last year's second quarter operating revenues included the rate case settlements.

  • Excluding that addition to 2005 operating revenues, the quarter-over-quarter increase in revenues would be 14%.

  • For the first six months volumes rose by 171,000 units, or 4%, while revenue per unit increased by 10%, to yield a 14% increase in railway operating revenues.

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

  • Railway operating expenses for the second quarter were 1.7 billion, up 153 million, or 10% compared with '05.

  • For the first six months railway operating expenses were 3.5 billion, 347 million, or 11% higher than '05.

  • The largest increase in operating expenses for the quarter was in diesel fuel, which was up 98 million, or 60%.

  • Second quarter diesel fuel costs surged to 260 million, compared with 162 million last year.

  • The primary driver of that increase was higher prices per gallon of diesel fuel, which added $60 million.

  • Our benefit from fuel hedging was $35 million less in the second quarter than last year, and consumption was up 3 million, or 2%, on the 4% increase in traffic volume.

  • As you will recall our hedging program wound down in May of this year, and the absence of fuel hedges make for even tougher comparisons for this year.

  • The next largest increase was in casualties and other claims expense, which rose 25 million, or 63% compared with last year.

  • In the last two quarters we've experienced volatility in our casualty and other claims expense, because of a greater number of derailments involving high value ladings such as automobiles, and also because of higher insurance costs.

  • More than half of this quarter's increase is attributed to lading and equipment costs associated with derailments.

  • The remaining variance is principally due to higher personal injury costs, and increased premiums for casualty and property insurance.

  • Material services and rents rose by 25 million, or 6% in the second quarter.

  • Within this category purchased services increased by 16 million, primarily for Intermodal services, reflecting the 8% increase in Intermodal traffic volume.

  • Materials expense rose 8 million, largely a result of maintenance activities, and equipment rents increased 1 million.

  • Compensation and benefits expense for the second quarter rose 13 million, or 2% compared with last year.

  • This increase is attributable to higher medical insurance costs for both active and retired employees which rose by $7 million.

  • Higher wage rates that added 6 million.

  • Increased hours for train and engine employees that added 4 million, and higher payroll taxes that added another 4 million.

  • These increases were offset in part by $6 million less in life insurance costs, and 2 million less in other miscellaneous items.

  • Depreciation expense was down 12 million or 6%.

  • As you will recall this was due to a required periodic depreciation study that was completed in the first quarter of this year, which indicated longer depreciable lives for some of our assets.

  • For the first six months railway operating expenses were up 347 million, or 11%.

  • As in the case of the second quarter the largest increase for the first half was in diesel fuel expense.

  • The $179 million increase in diesel fuel was largely due to higher prices, which accounted for $111 million of this increase.

  • The benefit from fuel hedging was 60 million less than last year, and increased consumption added 8 million.

  • The second largest increase for the first six months was in compensation and benefits expense, which increased by 130 million, or 11%.

  • As you will recall, we implemented FAS 123(R) on January 1, 2006, and our expenses include 33 million related to this change in accounting.

  • In addition, the increase in compensation and benefits includes 30 million of other stock-based compensation, primarily stemming from the increase in Norfolk Southern's stock price. 16 million for increased medical insurance benefits, 13 million related to retirement agreements and waiver agreements with two former executives in the first quarter, 13 million of higher payroll taxes, 12 million of increased wage rates, 11 million for the cost of the regular annual stock-based grant to the former Chief Executive Officer who retired in the first quarter, and 10 million reflecting the cost of additional hours for train service employees.

  • And other miscellaneous items reduced these compensation and benefit cost increases by about $8 million.

  • For the first six months material services and rents expense were 60 million, or 7% higher than the same period last year.

  • For the first half of the year purchased services rose 30 million, and materials expense increased 21 million, both reflecting higher traffic volume and increased maintenance activities.

  • Equipment rents were up 9 million, primarily due to increased volume.

  • For the first six months casualties and other claims were even with 2005, as current year derailment costs almost equalled the costs related to the Graniteville accident last year.

  • Depreciation expense for the first half decreased by 22 million, or 6% as a result of that depreciation study that we received in the first quarter.

  • The railway operating ratio for the second quarter was 71.7% compared with a ratio of 72.5% in the second quarter of '05.

  • This represents the best quarterly operating ratio since the integration of Conrail in 1999.

  • For the first six months the operating ratio was 73.8% compared with 75.8% for the same period last year.

  • Second quarter income from railway operations was a record 677 million, up 85 million, or 14% over the 592 million produced last year.

  • For the first six months, income from railway operations was also a record at 1.2 billion, up 233 million, or 23%.

  • Total other income and expense for the second quarter was an expense of 88 million compared with an expense of 117 million in '05.

  • Expenses related to our syn fuel investments were $18 million lower this year, reflecting the expected phase-out of a portion of certain Section 29 credits due to high oil prices.

  • Interest income rose 13 million over last year as a result of higher invested cash balances and higher interest rates.

  • Interest expense on debt was 5 million lower than last year, reflecting less debt outstanding.

  • For the first six months total other income and expense was an expense of 173 million, compared with an expense of 243 million in '05.

  • Expenses related to our syn fuel investments were $25 million lower than last year, again reflecting the expected phase-out of a portion of those Section 29 tax credits due to high oil prices.

  • Interest income increased 23 million, and gains on sales of property and investments were 12 million higher.

  • Interest expense on debt for the first six months was $13 million lower than last year, again due to less outstanding debt.

  • Our second quarter income before income taxes was 589 million, compared with 479 million last year, a 24% increase.

  • For the first six months income before income taxes was 1.1 billion, up 40% compared with 752 million in '05.

  • The provision for income taxes for the second quarter was 214 million, compared with 51 million last year.

  • As I mentioned a moment ago, last year was positively impacted by a $96 million non-cash tax benefit associated with changes in the Ohio tax laws.

  • The effective rate for this quarter was 36.3% compared with 10.7% last year.

  • The Ohio tax law change reduced last year's second quarter effective tax rate by 20.2 percentage points.

  • The remaining 5.4 percentage point increase in the effective tax rate this quarter, is largely the result of significantly reduced tax credits projected on our Section 29 tax credit investments.

  • As you will recall, we made investments in synthetic fuel operations that produced credits under Section 29 of the Internal Revenue Code.

  • These tax credits are reduced or phased-out, as oil prices reach certain levels specified in the law.

  • In the first quarter we experienced some reductions in the amount of tax credits available due to high oil prices.

  • With even higher prices in the second quarter, we're experiencing even greater reductions which have the effect of increasing our effective tax rate.

  • Because the tax credit of the tax credit phase-out, our second quarter reflects $34 million less in tax benefit from these credits, when compared with the second quarter of '05.

  • For the first half of the year, the provision for income taxes was 375 million compared with 134 million last year.

  • The effective tax rate was 35.5%, compared with 17.8% in '05.

  • The Ohio tax law change reduced last year's first half rate by 12.8 percentage points, and again the remaining 4.9 percentage point increase in the effective rate, is attributable to the phase-out of those Section 29 tax credits, due to the higher oil prices.

  • I should also point out that a complete phase-out of these credits for the year would result in the reversal of $9 million of net benefits, comprised of $17 million of pretax investment expenses, and $26 million of tax benefits, that have been recognized and accrued in the first six months of this year.

  • Second quarter net income was $375 million compared with 424 million reported for the second quarter of '05, which included the $96 million benefit associated with the change in the Ohio tax laws, and the $24 million related to the settlement of the coal rate cases.

  • For the first six months net income was a record 680 million, compared with 618 million last year, an increase of 62 million, or 10%.

  • Diluted earnings per share for the second quarter were $0.89 compared with $1.04 reported per share last year, and for the first six months diluted earnings per share were $1.61, which was 7% above the $1.51 per share reported a year ago.

  • Last year I provided you with a comparison of our net income and earnings per share excluding the effects of the change in the Ohio tax laws, and the settlements of the rate cases.

  • On that basis this year's second quarter net income of 375 million, would have been 71 million, or 23% higher than the second quarter of '05.

  • Our net income for the first six months of 680 million, would have been 182 million, or 37% higher than the same period in '05.

  • Similarly, our second quarter diluted earnings per share of $0.89 would have been 19% higher than the $0.75 per share earned in the second quarter of '05, excluding the Ohio tax law change and the coal rate case settlements.

  • Our year-to-date earnings per share of $1.61 would have been 32% higher than the $1.22 earnings per share earned last year calculated on the same basis.

  • In this slide reconciles the net income and earnings per share for the second quarter and first six months of '05, excluding the Ohio tax legislation and the two rate cases to our reported net income and earnings per share.

  • This reconciliation is posted on our website for your reference, and is available for you.

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

  • - EVP, CMO

  • Thank you.

  • Good morning.

  • It is good to be with you again.

  • First a couple comments on the economy in terms our experience with it up to this point.

  • The changing environment in the freight transportation industry certainly continued to benefit Norfolk Southern during the quarter.

  • Our performance is running counter to some of the current economic trends, and our metrics continue to outpace the economy, motor carrier growth, and other rail carriers.

  • Since the first quarter of 2001, our volume has risen by 22% compared to increases of 15% at other U.S. railroads, and 9% for both truck tonnage and low tech industrial production.

  • It appears as intended by the Fed, it appears that higher interest rates are slowing the economy, resulting in GDP growth of 3.3% in the second quarter, versus 5.6% in the first quarter.

  • Primary factors in the decline no surprise, weaker residential construction, coupled with a lag in consumer spending.

  • Interest rate increases have been the driver of the softness in construction, and obviously the drop in consumer spending seems to be a reflection of rising gas prices.

  • After a spike in April, the ISM index receded to 53.8, its lowest reading since August 2005.

  • During this rise and fall of the ISM, manufacturing has continued to expand.

  • While the pace slowed for the quarter, manufacturing saw a renewed level of activity in June which bodes well for the second half.

  • Despite the slowing economy, our volume continued to grow during the second quarter, up 4% over the same period last year, as well as 4% for the year-to-date.

  • We reached a new milestone during the quarter and exceeded 2 million units for the first time, led by strong gains in Metals and Construction and Intermodal traffic.

  • A fluid network and continuous improvement in asset utilization enabled us to reach this record volume.

  • Looking at our markets, merchandise volume increased 1% for the quarter, and 2% for the six months, in spite of declines in Automotive, Chemicals, and Agricultural business.

  • Metals and Construction business set another volume record during the quarter, as volume was up 10% for the three months, and 11% for the year.

  • Our Intermodal business continued to be strong driven by robust international and truckload business, as volume was up 8% for both the quarter and the year.

  • And Coal volumes were up 2% for the quarter, and 3% for the year.

  • Strong metallurgical coal demand for steel and utility stock pile rebuilding helped this sector reach a record loading month during May as Wick mentioned, and our second highest quarter ever.

  • Turning to revenues we recorded our eleventh successive quarter of revenue growth.

  • Total revenues reached 2.4 billion for the quarter, increasing 238 million, or 11% over the same period last year.

  • With the exception of Ag and Intermodal our remaining business groups reported all-time records for the quarter.

  • This included coal despite the addition of $55 million for the settlement of the coal rate cases in the second quarter of 2005, as Hank mentioned.

  • For the six months revenue of 4.7 billion, was up 580 million, or 14% versus the first half of 2005.

  • For the quarter, we also achieved record revenue per unit reaching $1,182, continued strong transportation demand and tight capacity bode well for market based pricing in the quarter.

  • Broader fuel surcharge coverage and higher fuel prices also contributed to these gains, and represent approximately 60% of the increase in revenue per unit.

  • We now estimate that 90% of our revenue base is covered by fuel surcharges.

  • That's up from 85% coverage at the end of 2005.

  • With respect to the individual business groups, merchandise revenue per unit of 1,737 was an all-time high.

  • Rate increases across the board, changes in traffic mix, and fuel related revenue drove this performance.

  • Intermodal's revenue per unit reached 605 for the quarter and $600 for the year-to-date.

  • These gains resulted from fuel surcharges, longer haul traffic, and rate increases somewhat offset by the continuing trend of the conversion of highway trailers to containers.

  • Coal revenue per car was down $10 for the quarter, but up $78 for the six months.

  • In 2005 $126 and $64 were added to coal's revenue per unit for the second quarter and six months respectively, for the effect of the coal rate cases.

  • Coal RPU excluding the rate case effect would have been up 10%, or $116 per car for the quarter.

  • Finally, we experienced a 26% reduction in higher rated export coal volume, which reduced revenue per unit in the quarter as well.

  • With respect to our fuel surcharge program, just a quick comment as you already know our new fuel surcharge was announced in April, and implemented on July 1st.

  • This new program rebases fuel to our originated public prices on car load freight, non-Intermodal tariff freight to $64 per WTI per barrel of crude oil, and increased the line haul transportation rates on this traffic by 16.4%.

  • Now, turning to our individual markets, merchandise revenue of 1.3 billion for the quarter, was an all-time high exceeding second quarter '05 by 163 million, or 14% on a 1% gain in volume.

  • For the year revenue reached 2.6 billion, up 16%, on a 2% increase in volume.

  • Metals and Construction led both revenue and volume growth for our car load business for the quarter.

  • Revenue reached 304 million for the quarter in this sector, and 583 million for the year.

  • A 37% gain in iron and steel shipments drove this increase.

  • Improved import and domestic intermill steel slab trains during the quarter, were the primary components of the increase.

  • Looking ahead world steel demand is projected to remain strong for the remainder of 2006, driven by higher infrastructure investment, and continued growth in India and China.

  • Demand in the United States continues to also be strong, as high energy prices are driving demand for plate, pipe, and specialty steels.

  • Our Construction markets were bolstered during the quarter due to strong commercial and public construction projects.

  • Aggregates and cement were up 3% and 19% respectively over last year, and this could have been even higher if not for wet weather that impacted work schedules.

  • Paper revenue increased 14% to 224 million for the quarter, and 438 million for the six months.

  • Much of the growth in this sector is occurring within the solid waste markets, which prior to this year was reported in our Chemicals group, and more than offset declines in some of our paper segments.

  • For the remainder of 2006 we expect to see softer demand for paper, with potential upside as the demand lessens in this market, we could see a reduction in order lead-time pressures, allowing more shipments to move via rail versus truck.

  • Our second quarter Lumber shipments were largely flat compared to last year, but revenue was up 14%.

  • While the housing market shows signs of cooling after several years of record levels, we expect the impact to our rail shipments to be somewhat less than anticipated housing start declines, due to improving car supply and new industrial development projects.

  • Our remaining merchandise groups experienced volume softness for the quarter.

  • Agriculture revenue of 239 million, was up 39 million, or 20%, while volume fell 1%.

  • For the year Ag's growth outpaced our remaining business sectors with a gain of 113 million, or 29%.

  • During the quarter, we experienced volume declines in fertilizers, especially imported Canadian potash and domestic phosphate fertilizers, due primarily to high energy costs.

  • Wheat and soybean volumes declined as well.

  • As I previously reported, FEMA temporary housing for the Katrina storm victims have been reported in the Agricultural Government and Consumer Products group.

  • Since September of 2005 when Katrina struck, we've handled 13,750 car loads, with about half of that volume moving in the first four months of 2006.

  • This movement concluded in late April.

  • It is no longer moving, but we are currently working with FEMA on other projects, in preparation for this year's storm season.

  • In past reports I have also mentioned our Southeastern feed mill network.

  • We added an additional feed mill to that network that will open in August at Manetta, South Caroline, and we also improved asset utilization in the quarter at our 75-car grain shuttle trains turned 3 times per month during the quarter, compared with 2.5 turns for the first half.

  • We also continue to see opportunities in the alternative fuels market.

  • Louie Dreyfuss broke ground on it's 80-million gallon biodiesel fuel facility at Claypool Indiana in May, which will be served by Norfolk Southern.

  • Central States Enterprises announced a 100-million gallon ethanol plant at Montpelier, Indiana, again a new facility on Norfolk Southern.

  • With respect to ethanol there are numerous plant site projects under consideration on our system, 14 of which have a high probability of being constructed in the next 12 to 18 months, and could generate capacity in excess of 850 million-gallons of additional ethanol.

  • Turning to our Automotive market, Automotive revenue reached 276 million for the quarter, and 538 million for the first half, as volume fell 3% for both periods.

  • Revenue gains were the result of market-based price adjustments, coupled with fuel cur charges.

  • Vehicle parts saw a reduction of 16% in volume for the quarter, offsetting a 2% increase in overall finished vehicle traffic.

  • Volume was impacted by the closure of Ford's assembly plant in St. Louis, Missouri, and General Motors assembly plant in Oklahoma City.

  • Looking ahead, Automotive volume will once again be impacted during the second half of the year, as Ford and GM continue to realign their production capacity with market demand.

  • Ford will close its assembly plant in Atlanta, Georgia in October, which we serve.

  • However, these volume declines at Ford and CM will be partially offset by expansion at Vance, Alabama by Mercedes Benz, as well as the release of new products from DaimlerChrysler at Belvidere, Illinois, and Sterling Heights, Michigan.

  • Our volumes from various International producer, such as Toyota and Honda and others with plants in the U.S. increased by 7% in the quarter, and 8% for the year.

  • Looking ahead, in terms of total Automotive business, we expect Automotive revenue to continue its growth, despite volume declines with Ford and GM.

  • Finally Chemical revenue grew to 268 million for the quarter, and 524 million for the year, on volume declines of 8% and 7% respectively.

  • With the exception of the Plastics, our remaining chemicals markets experienced volume declines during the quarter, related to plant closings and production cuts.

  • Weaker housing and automotive activity coupled with high energy costs are impacting chemical production and demand.

  • Finally as I previously mentioned, Solid Waste traffic which was reported in Chemicals last year, is now reflected in paper and forest products.

  • This traffic shift of solid waste represents about half of the reported volume decline in the Chemical group for the quarter.

  • Now turning to our coal business, second quarter revenue of 584 million was up 6 million, or 1% over second quarter of '05.

  • Excluding the coal rate settlement of 55 million in the second quarter of last year, second quarter revenue would have increased by 61 million, or 12% in the quarter.

  • With record highs in coal volume for the month of May, car loads and tons were both up for the quarter and year, with a gain of 2% and 3% respectively over 2005.

  • Strong demand in the Utility business resulted in the gain of 6% for the quarter, which is on-pace with a 6% increase year-to-date.

  • High natural gas prices coupled with the replenishment of utility stockpiles were the primary drivers of these gains.

  • Looking ahead natural gas prices and heavier summer demand for electricity, should continue to drive strong utility coal loadings in the months ahead.

  • Metallurgical steel volume grew 8% for the quarter, down from year-to-date growth of 14%, while Coke carloads rose 10% in the quarter, raising the overall growth this year to 8%.

  • Both increases are attributed to continued strength in steel demand, and new Coke production at Haverhill, OH.

  • This favorable trend is generating opportunities for us to handle new lanes for metallurgical coal and Coke at current market pricing.

  • We expect this trend to continue over the remainder of the year.

  • In our other three coal market segments, Exports, Iron Ore, and Industrial, we experienced year-over-year declines.

  • Export was down 26% this quarter, bringing the year-to-date volume 23% below 2005.

  • Decreases were attributable to high coal inventory levels at European mills, the closure of a foundry Coke production facility in France, a blast furnace outage in Brazil, and the departure of Asian demand from the U.S. market this year.

  • Iron ore shipments were down 22% for the quarter, and 35% for the half with a continued effect of the loss of a large movement of iron ore in the wake of Mittal Steel closing its blast furnace in Weirton, West Virginia.

  • As I just mentioned for the remainder of '06 we expect strong volumes in our Utility and Metallurgical business.

  • The Export market is more problematic, although we are cautiously optimistic that second half volumes will expand in the face of lower coal inventories in Europe, and stronger steel production.

  • With respect to capacity in our coal network, we continue to model and enhance our capabilities, which in turn improves asset utilization and overall performance.

  • Revenue per car day for system equipment in coal increased nearly 8% for the first six months, and 7% in the second quarter.

  • Revenue per locomotive day had a good gain as well, up 7.5%, and we continue to see improvement in transit days per load as well.

  • Now, turning our attention to Intermodal, Intermodal continued its solid growth trend as second quarter revenue of 497 million was our second highest quarterly revenue ever.

  • For the year revenue reached 963 million, up 15% over 2005.

  • The volume growth in Intermodal continues to be led by our international business, which was up 16% for both the quarter and the year.

  • Continued strength in import and export volumes, as well as new business secured during the second half of '05, are driving these business gains.

  • Our volumes through East Coast ports grew 10% during the quarter, while West Coast port volumes were up 20%.

  • Volume growth should remain strong going into the third quarter, but comparisons will be more difficult, due to new business added in the third quarter of 2005.

  • We also continue to see declines in our domestic IMC business, which is down 9% for the quarter.

  • The downsizing of the North American Container systems program are next, and the decline of the free-running railroad control trailer fleet, has impacted volume for both the quarter and year.

  • Looking at the other side of our domestic business, truckload volume was up 11% for the quarter, and 12% for the half.

  • We continue to create joint markets with our truckload customers, enabling us to convert traffic from the highway in the face of tight trucking capacity.

  • Truckload increases will continue to mitigate the decline in IMC business as we move forward, as this sector is better positioned with private equipment fleets to offset the effects of the NACS-related equipment decline, and fewer highway trailers available for Intermodal.

  • Finally we continue to enhance our Intermodal network and capacity with terminal and service improvements.

  • I mentioned some of these terminal expansion projects in my April report.

  • Our new Louisville, Kentucky, Intermodal terminal opens next month, and will serve container traffic moving over Detroit, Kansas City, and Chicago destined to the Louisville market.

  • Expansions in Atlanta at Austell, in Chicago at our Landers Intermodal terminal, Cleveland at Maple Heights, and our Croxton, New Jersey terminals, should also be completed by the end of this year.

  • In summary, as we look ahead, we feel our diverse portfolio of business presents solid opportunity for growth going forward, despite the winds of economic change and uncertainty, brought about by rising interest rates and high energy costs.

  • In times of high fuel prices, rail more than ever is the mode of choice for efficient and environmentally sound transportation.

  • We plan to continue to improve our service and capacity, and realize the opportunity at market prices, that reflect the overall value of our service.

  • Thank you, and with that I will turn it back over to Wick.

  • - President, CEO

  • Thank you, Don.

  • Well, let me open it up for questions here, and I will start in the very back.

  • - President, CEO

  • Scott?

  • - Analyst

  • Yes, Scott Flower.

  • B of A Securities.

  • Probably a question for Hank, but I wonder if you can give us some color what we should preponderance for the effective tax rate, whether the run rate in the second quarter is what we should see in the second half, what might cause the reversal of that 9 million of net accrual.

  • Is that already going to happen second half from what you already accrued in the first quarter, and then lastly, maybe a little color on what oil prices effect some of the implications on what the syn fuel credits may or may not be.

  • You mentioned there were some oil price clip levels in the legislation.

  • I know that is complicated but maybe there are some oil price clip levels that matter.

  • - Vice Chairman, CFO

  • I would say that going forward for the second half, a reasonable expectation would be that the effective rate will certainly be between 36 and 37%, probably closer to 37.

  • With respect to the $9 million of benefit that has been accrued, that is on the basis of prices that we've experienced in the first half of the year, and a projection, you have to make a projection based on the forward curve looking out.

  • So to the extent that actual prices deviate from today's forward curve, that could cause either that $9 million to be reduced, so that we are in essence reducing the tax benefit, or to the extent prices fall and are more favorable, we may have a pick-up there.

  • We just can't forecast this at this time, because we don't know what the oil prices are.

  • The phase-out for those credits begins at about $60 a share --

  • - EVP, CMO

  • A barrel.

  • - Vice Chairman, CFO

  • Excuse me, a barrel, and at probably $75, they're completely gone.

  • - President, CEO

  • Tom.

  • - Analyst

  • Good morning, Tom Wadewitz from JP Morgan.

  • Two questions for Wick or Don.

  • When you look at the economy right now, and you look at the pace of volume growth in first quarter, do you think it is reasonable to believe that you could continue to see that kind of 4 to 5% type of all-line unit growth, and also on the yield growth, if we deduce a couple different components of that with the price and fuel surcharge and so forth, and is there any color you can give us on what the pace of yield growth might be in second quarter?

  • Is that going to fall a lot, as the fuel comparison, fuel prices were higher and less fuel surcharge, or do you think the yield growth can kind of continue roughly around where we are?

  • - President, CEO

  • Let me take a stab at the first half and then Don, if you want to talk about the fuel.

  • We do as we've all discussed, watch our volumes very closely, and try and determine where any potential weaknesses are.

  • One of the things I would think is fair to say, is that we're sorting through ourselves today and don't really have the answers for, is the discussion that we have all been having for the past couple of years, as to how much of our volume growth right now is because of underlying changes in the transportation marketplace, and is secular rather than cyclical.

  • I think it is fair to say that even if there is an economic slow down, it is not clear to us what we're going to see in terms of potential traffic slowdown.

  • In fact, there is some arguments that in fact, our a lot of our traffic will remain very good, regardless of some issues in the economy, but our best evaluation right now, based on what we're currently seeing, and what Don and all of his people are hearing in the marketplace, is that we don't anticipate a substantial difference in volume growth in the second half, than we've seen in the first half.

  • That's where we are, Don, and why don't you comment on the fuel.

  • - EVP, CMO

  • I am very comfortable with that, Wick, in terms of the second half looking at the third and fourth quarters, volume appears to be poised to be at a run rate of what we've seen in the second quarter, certainly Coal business will continue, in terms of the Utility and Metallurgical market with its growth, Intermodal is poised for further growth in the second half.

  • Our Metals and Construction business will continue to grow, order books at the Steel manufacturers look pretty good.

  • They're telling us they're at capacity or close to capacity in terms of the run rate for the second half.

  • So, volumes of 4% in that range we feel fairly comfortable with that.

  • With respect to the second part of your question, with respect to yield, obviously as we continue to lap year-over-year comparisons with the impact of fuel surcharges, and the timing of renegotiation of quotes and new contracts, we will start to see some moderation year-over-year.

  • We're at 90% coverage on fuel.

  • That tells us that we're higher up on the tree to pick the fruit, so that will be a little bit more difficult for us to continue to move that needle, but we're committed to moving that needle, but I would say the impact of fuel will moderate year-over-year.

  • - Analyst

  • Just one follow-up, and I will pass it along, but there is a question out there I think about if natural gas prices fall, you know, they've fallen somewhat and bounced back recently, but if the storage is filled up, and you've seen the cash market a meaningful decline in say September, October, do you think your Utility coal will have sensitivity to that, or given the outlook now you think that really won't be a meaningful impact in terms of the natural gas?

  • Thank you.

  • - EVP, CMO

  • At the current price gas is about $6, and the January outlook projects a range of $9.50 to $10.

  • With those prices for natural gas, we feel coal will be the choice, the fuel of choice for utilities.

  • Now, that's notwithstanding anything that's going to happen with the disruption of gas supply with the upcoming hurricane season.

  • Hopefully we won't have disruption, but it looks like the forward curve on gas at $10 to $11 by January, puts it way out of range with respect to being competitive with coal for utilities.

  • - President, CEO

  • And to build on that, I think that the sense we get from our utility customers in terms of their leaning towards coal versus gas is that very few if any of them are convinced that there is going to be any sustained lower level of natural gas prices, and even if you saw a month or two where it dipped below $6, I don't think that's going to influence the coal buying patterns of the utilities in any real way.

  • - Analyst

  • Wick, it is Tony Hatch.

  • I don't know if Don or you were talking about the breakdown in yield, and how fuel surcharge percentage, and I was scribbling.

  • I don't know if you talked about where rate, if your price came in on that, and if you did and I missed it could you repeat it?

  • Specifically I would also like some color on where within the good Intermodal story going on, what's happening in year-over-year pricing on that, and where you expect to see that, and then if Steve could talk a little about what's going on with the derailment story for the Harriman winter, you didn't think you were going to get away with it, did you.

  • - President, CEO

  • Steve is poised, but, Don, why don't you --

  • - EVP, CMO

  • Tony, the first part of your question, with respect to fuel for the quarter, it was 60% of the revenue per unit growth, fuel was 60% of the revenue per unit growth increase.

  • Now, that was somewhat impacted by the year-over-year comparison, again of the $55 million, so you will need to take a look at that.

  • The second part of your question on Intermodal, we continue to see good demand, strong demand for Intermodal, the truckload numbers that I showed you support that.

  • Our international business continues to be very strong at 16% for the quarter and for the half.

  • We see that continuing, and as far as the demand we price to the market and with a demand like that, obviously we're looking at yields as we go forward, yield improvement as we go forward.

  • - President, CEO

  • We continue to see a good pricing environment there as well.

  • Steve, come on up and because there is a story about what we kind of think is somewhat of an anomaly versus what is actually happening with our statistics on things like train accidents.

  • - Vice Chairman, COO

  • Tony, I am not sure I can put your question in exact context, because the references that we've made to derailments is different than the Harriman configuration, which is just based on personal injury.

  • All right.

  • I want to be sure I was clear on which direction you wish to go.

  • Our view is we still from a personal injury standpoint, our employees are doing quite well, and we feel comfortable with the position that we're in today on our personal injury experience, and the safety effort that goes on on our property.

  • Hank's commentary about derailments and the impact on the casualty line, we have had some derailments in, and I would say not an extraordinary number by any stretch of the imagination.

  • We have had some derailments that occurred in what I would describe as key areas.

  • Those derailments unfortunately embodied some higher revenue, high value commodities, which further exacerbated the impact of the cost.

  • There was nothing systemic in the causes.

  • In fact, in the last fifteen years, and I am doing this off the top of my head, in accidents per million train miles, I think you will find that it as far and away has led the industry in derailments, train accidents per million train miles category, and I think the numbers will reflect at the end of the year, that we'll still be in that type of position.

  • - President, CEO

  • I think we've actually shown a little decline --

  • - Vice Chairman, COO

  • Actually, year-over-year as far as to date we have a decline in train accidents per million train miles this year versus last.

  • - President, CEO

  • Sometimes we have an accident with a bunch of empties, and sometimes we have a few accidents that have some automobiles, or things like that, and that just kind of is an anomaly.

  • - Analyst

  • I just want a couple clarifications on previous answers.

  • - President, CEO

  • And who might you be?

  • - Analyst

  • Ken Hoexter from Merrill Lynch.

  • Hank, on the tax rate line, obviously the tax rate jumps up maybe to 37%, but do we get a reduction in the other income expense line that offsets a portion of that?

  • Does that completely go away as well?

  • - Vice Chairman, CFO

  • There will be some reduction in the other income line, the second it was $18 million, but there is also a $7 million tax benefit from the deduction that's associated with that expense, so net it is 11 million for the quarter.

  • On a go-forward basis there will be some reduction there, but all-in the major effect is on the tax line.

  • - Analyst

  • Okay.

  • And just to clarify what you're saying on that last answer, 60% of the 7% average revenue per car increase was fuel related, so pure pricing on mix was up 3%, does that same 60% apply to the 9.5% if you normalize for the coal, and you are still up then what 5.5%, 6% on fuel, and that means still 3% on pure pricing?

  • - President, CEO

  • Don is going to sort that out for you.

  • - EVP, CMO

  • That was a very complicated question you just asked there, Ken.

  • We had a negative mix effect in the quarter.

  • When we look at fuel, again, we're looking at that delta between '05 and '06 quarter-to-quarter, in terms of RPU, so we had the volume increase, and we had that RPU increase, which 60% was fuel, but mix was negative to the tune of about 3%.

  • - Analyst

  • Perfect.

  • All right.

  • My question on the comp and benefits line, I understand there were options in the first quarter, but if you look at the growth on account the benefit per employee was up quite significantly in the first quarter.

  • If I look this quarter, Hank noted it was up 3%.

  • Last year you kind of sustained about a 2% increase.

  • I am just wondering if that reduction in life insurance costs, which I am sorry, last year it ran at a 3% rate.

  • Now it is up only 2%.

  • I am wondering if that reduction in life insurance costs is kind of a one-timer, and we should expect comp and benefits per employee to jump back up to that 3% run rate.

  • - President, CEO

  • Hank, why don't you comment on the insurance issue?

  • - Vice Chairman, CFO

  • Last year we had a one-time expense for the life insurance.

  • This year we didn't, so when you're making the comparison, I was simply trying to call your attention to the fact that we didn't have that item again.

  • It was a one-time item.

  • - Analyst

  • Yes.

  • - Vice Chairman, CFO

  • But I think that there are a lot of moving parts in comp and benefit.

  • The largest moving part is the stock price, and obviously there was some significant increase in stock price in the first quarter, that helped to drive that, which we did not have in the second quarter.

  • - Analyst

  • Right.

  • - President, CEO

  • We're always, and we will try to help with this, you know, because of the effects of new accounting effects, we're always going to have an erratic first quarter it looks like, and we will continue, as Hank says, to have a little volatility in comp and benefits, based on the stock price which is nothing new.

  • We've always had it.

  • That in fact will continue.

  • - Analyst

  • Just last one, we saw pretty decent deceleration in the coal and Ag yields.

  • Wondering if there is anything specific there, or if that is for a fuel comp year-over-year, a deceleration on the growth rates of the first quarter.

  • - EVP, CMO

  • Ken, again, on a quarter-over-quarter basis, take into account the rate case effect from '05.

  • On the Ag side, I mentioned the FEMA traffic, and we had that moving at a heavier rate actually through almost all of April, so it was the first quarter and a portion of April, almost 14,000 cars at a higher RPU than the average in Ag, so take that into account.

  • There is nothing really different within Ag.

  • Coal other than the rate case there is nothing there in terms of changing in yield.

  • The business mix was pretty much the same, although we did have a little bit more traffic to the river on the Utility side.

  • - Analyst

  • A little less export.

  • - EVP, CMO

  • A little less export which impacted RPU as well with export being down 26%.

  • - Analyst

  • Yes.

  • We didn't see any signs of weakness in either one of those sectors.

  • - EVP, CMO

  • No.

  • - Analyst

  • It is Tom [Water with Skenetic].

  • Just a follow-up question for Don.

  • You're the popular guy today.

  • You mentioned ethanol plants.

  • I think you said 14 to potentially coming online, I don't know if that is '07 or '08.

  • Can you give us a broad brush sense of what that might translate to, in terms of revenue or cars for Norfolk Southern, and whether we should think of it as more of an '07 or '08 type of impact?

  • - EVP, CMO

  • I would say the 14 are the ones with the higher probability.

  • We have got more projects than that on the drawing boards.

  • Most of these plants are capable of building a facility and bringing it up to production within an 18-month period.

  • They're well along, the Montpelier, Indiana plant that I mentioned for Central States Grain, is already permitted, it is already announced, and they've started construction.

  • I would say a mix over the next 18 months you can take that into accounted.

  • On the 850-million gallons that I mentioned, the run rate generally on ethanol is about 20 million-gallons per car.

  • - Analyst

  • 14 plants at 850 million gallons --

  • - EVP, CMO

  • Million gallons, at about 20,000 gallons per car. 20,000 gallons per tank car.

  • - Analyst

  • 20,000 per tank car.

  • - EVP, CMO

  • That assumes is would all move rail, which it may not, there might be some local trucking to a plant facility, but generally these ethanol plants ship predominately rail.

  • - Analyst

  • And that comes on the at ethanol tends to be relatively higher revenue per car, versus your average for Ag, is that fair?

  • - EVP, CMO

  • It depends on the length of haul and the market it is going to.

  • I really can't give you a good straight answer on that.

  • - President, CEO

  • And that's because it is in a state of transition.

  • The markets for ethanol are expanding and changing, and we're going to have some ethanol that moves longer distances and shorter distances, and it is somewhat dependent on where these 14 plants decide to market their product.

  • - EVP, CMO

  • That's right.

  • That's right.

  • - Analyst

  • Okay.

  • Thank you.

  • - Analyst

  • Just a quick minor point, but on the share repurchase plan is your goal to actually reduce shares outstanding, or just to replace all of the options that we've seen?

  • - President, CEO

  • Well, let me answer that.

  • Our goal as we have said is we've announced a program, and our goal right now is to buy shares at a consistent rate.

  • I would say we will consider taking advantage of anything we perceive in terms of weakness in the share price to maybe buy a few more, and our long-term goal initially is to control dilution as we've told a lot of people, and to bring the number of shares back down to hopefully over a reasonable period of time, to about a 400 million level and control it there.

  • That's our initial thought with the program, but we have a lot of flexibility in it, and if we change our goals we'll talk about it.

  • Hank, did I leave anything out?

  • - Vice Chairman, CFO

  • Thanks.

  • I forgot to mention that was Ken Hoexter from Merrill Lynch.

  • - President, CEO

  • All right.

  • Well, I don't see any more hands.

  • Thank you very much for coming.

  • It is a pleasure to see all of you.

  • Thanks, everyone for listening in, and we look forward to talking to you again in about three months.