Norfolk Southern Corp (NSC) 2008 Q1 法說會逐字稿

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  • Operator

  • Greetings and welcome to the Norfolk Southern Corporation first-quarter earnings conference call.

  • At this time all participants are in a listen-only mode.

  • A brief question-and-answer session will follow the formal presentation.

  • Questions will be taken first from those in attendance at the meeting, then from those participating over the phone.

  • (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded.

  • It is now my pleasure to introduce Norfolk Southern Director of Investor Relations, Leanne Marilley.

  • Thank you, you may begin.

  • Leanne Marilley - Director IR

  • Thank you and good morning.

  • Before we begin today's call I would like to mention a few items.

  • First we would like to welcome you to our first-quarter earnings conference call.

  • We remind our listeners and Internet participants that the slides of the presenters are available for your convenience on our website at nscorp.com in the investor section.

  • Additionally, MP3 downloads of today's meeting will be available on our website for your convenience.

  • As usual, transcripts of the meeting also will be posted on our website and will be available upon request from our corporate communications department.

  • At the end of the prepared portion of today's call we will conduct a question-and-answer session.

  • At that time, if you choose to ask a question, an operator will instruct you how to do so from your telephone keypad.

  • 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.

  • Statements that are forward-looking can be identified by the use of words such as believes, expect, anticipate, and project.

  • Our actual results may differ materially from those projected and will be subject to a number of risks and uncertainties, some of which may be outside of our control.

  • Please refer to our annual and quarterly reports filed with the SEC for discussions of those risks and uncertainties we view as most important.

  • Now it is my pleasure to introduce Norfolk Southern Chairman, President, and CEO, Wick Moorman.

  • Wick Moorman - President

  • Thank you, Leanne, and welcome back and good morning, everyone.

  • It's my privilege to welcome all of you to our first-quarter 2008 analyst conference call.

  • We have with us today several members of our management team, including our Vice Chairman and Chief Operating Officer, Steve Tobias; along with Don Seale, our Executive Vice President and Chief Marketing Officer; Jim Squires, our Executive Vice President, Finance, and Chief Financial Officer; and John Rathbone, our Executive Vice President of Administration.

  • We're also joined by [Rob Kessler], our Vice President of Taxation; Bill Romig, Vice President and Treasurer; and Marta Stewart, our Vice President and Controller.

  • Turning to the first quarter, Norfolk Southern delivered strong financial performance reporting the highest railway operating revenues in its history in spite of a less than robust economy.

  • We earned record first-quarter revenues of $2.5 billion, which produced operating income of $578 million, an increase of 9% over first quarter of 2007, even with the increase in legal expenses related to the settlement of litigation tied to the Graniteville accident.

  • First quarter net income grew year-over-year to $291 million, or $0.76 diluted earnings per share.

  • Our results continue to validate our focus on delivering a higher value service product which allows us to maintain strong pricing across our commodity group.

  • The economy is turning out to be a little softer than we had originally anticipated when we looked at it towards the end of 2007.

  • But Norfolk Southern's balanced business portfolio, which is something you've heard us talk about a great deal in the past, along with our service, has helped to offset the down turns in some of our consumer and housing related businesses.

  • From an operations standpoint, the railroad is running smoothly and our service of metrics improved year-over-year for the first quarter.

  • Capacity enhancements that we've put in place and our continued focus on the reliability of our locomotive fleet and other assets are allowing our system to run more and more efficiently.

  • Additionally, the inclusion of the composite performance measure in our compensation package, which we talked about in last quarter's analyst meeting, has sharpened our employees' focus even more on our operations which translates directly into better service levels.

  • I'll talk more about this a little later, but it is worthwhile to note that a recent Morgan Stanley shipper survey confirmed the improvement in our already industry-leading service.

  • Finally, we continue to plan for the future.

  • We believe that the factors that support long-term growth in rail freight demand remain in place, and we're confident that volumes will resume growing as the economy rebounds.

  • When that happens, we will be poised to capture and handle that growth just as we did in 2003.

  • Rickenbacker Global Logistic Park in Columbus, Ohio, opened during the quarter and work is in progress on the tunnel clearances on the Heartland Corridor, which remains on schedule for completion in 2010.

  • As you'll see in Don's presentation, these improvements will provide a significant competitive advantage for Norfolk Southern as global trade patterns continue to shift towards east coast ports.

  • Additionally, we are continuing our dialogue with the Federal and State Governments about the win-win opportunities presented by the Crescent Corridor and work is already underway with support from the commonwealth of Virginia to add capacity in this key domestic freight lane.

  • I'll now turn the program over to Don Seale who will walk you through our first quarter results from a revenue and volume perspective.

  • Jim Squires will follow with the financial overview, and then I'll return with some closing comments before we take your questions.

  • Don?

  • Don Seale - EVP - CMO

  • Thank you, Wick, and good morning, everyone.

  • During the first quarter we continued to deal with the effects of a slower overall economy led by softness in housing-related commodities and the automotive market.

  • In spite of these challenges I'm pleased to report that we generated record revenue in the quarter of $2.5 billion up $253 million, or 11%, over the first quarter of 2007.

  • Merchandise revenue was up $124 million in the quarter as new records were set in agriculture and chemicals.

  • Coal revenue increased by $105 million, or 19%, which also represented a new record high.

  • Intermodal revenue was up $24 million, or 5%, despite excess trucking capacity and shifting global trade patterns.

  • The two primary drivers of the revenue increase across our markets in the first quarter were improved yield and fuel revenue.

  • Of the total increase of $253 million in the quarter, a little more than half of the gain came from pure pricing while the balance attributed to higher fuel revenue.

  • With respect to yield, as shown in slide three, revenue per unit reached an all-time high, up $166, or 14%, over the same period last year.

  • This was our 22nd consecutive quarter of year-over-year RPU growth and each of our major groups except automotive reached an all-time high.

  • Continued strength and pure pricing, which averaged 7% for the quarter, combined with higher fuel revenue generated these record results.

  • Now turning to volume, on slide four, you will note that we handled 1.8 million units in the quarter, which was 2% below last year, as weakened economic conditions continued to suppress rail freight transportation.

  • Increases in agriculture, coal, and metals traffic could not offset losses in our consumer-driven and manufacturing-related sectors.

  • It's also worth noting that volume gains were posted in the first two months of the quarter which were offset in March as one less working day and the timing of the Easter holiday impacted loadings.

  • Finally, the continued weakness in the U.S.

  • dollar helped drive volume gains in export products such as coal, grain, and machinery.

  • Total export volume surged by 14% in the quarter while total import volumes declined by 7%.

  • Now turning to our individual markets on slide five, Intermodal revenue reached $486 million for the quarter up 24 million, or 5%, as higher average revenue per unit overcame lower traffic volumes.

  • Record revenue per unit of $656 was driven by a more favorable traffic mix, improved pricing, and fuel surcharge revenue.

  • Higher-rated Intermodal marketing company, LTL and Triple Crown traffic grew while volumes and lower revenue per unit ocean and domestic containers declined.

  • Also we handled fewer revenue empties for private equipment owners in the domestic market.

  • Also during the quarter strong export demand converted empty ocean container movements to loads, which also helped boost average revenue per unit.

  • And finally, Triple Crown benefited from additional long-haul traffic in its business.

  • Within the individual market segments in Intermodal, as depicted on slide six, our international volume fell 5% for the quarter driven primarily by a softer economy and resulting import weakness, as well as the ongoing reduction of inland rail movement of West Coast import containers.

  • Higher inland transportation costs are prompting several major ocean carriers to restructure the way they're doing business in North America.

  • We continue to see ocean carriers placing more vessel capacity in the highly profitable Asian-European trade and eliminating less profitable inland transportation service to certain markets in the U.S.

  • In cases such as Maersk Lines and others, long-haul transcontinental markets have been replaced with all water service to the East Coast ports.

  • As a result of this trend, our total volumes associated with West Coast ports declined 16% in the quarter while volumes through East Coast ports increased by 8%.

  • Slide seven illustrates the changing nature of our international flows and the trends I just discussed.

  • For the quarter, total import volume fell by 8,000 loads while export volume increased by 8,300 loads.

  • As part of this changing international landscape, we saw a decline of 17,000 units in the movement of empty containers back to port locations during the first quarter.

  • Many of these boxes which previously moved in empty revenue service are now being used to support growth in exports.

  • As you can see from this slide, over half of our international traffic in the first quarter moved over the East Coast ports.

  • As depicted on slide eight, our total domestic and truckload volumes decreased 5% for the quarter reflecting a softer economy and the loss of Schneider National's business into the southeastern market.

  • Intermodal marketing company volumes grew 2% somewhat offsetting the decline in the truckload and domestic segments.

  • The increase reflect the relative efficiency of Intermodal versus over-the-road transportation in today's high fuel cost environment.

  • Our premium business, which includes parcel and LTL carriers, was down 2% as LTL conversions from the highway partially offset softer parcel and empty trailer repositioning volumes.

  • And Triple Crown was up 2% in the quarter due to expansion of our fleet and improved rail service over our network.

  • With respect to Intermodal demand during the quarter and ahead, there are clear signs of escalating demand across our network and, in particular, within the eastern half of our market.

  • Trucking continues to grow more expensive, and as we introduce new Intermodal lanes and products and our service performance reaches new highs, we are seeing additional opportunities.

  • And with respect to service, as shown in slide nine, our strong performance is being recognized by our customers.

  • During the quarter, UPS recognized Norfolk Southern for our commitment and dedication to providing consistent and reliable service throughout our network.

  • UPS requires strong service performance in support of its customers and we are proud to provide that level of service to UPS and to be recognized accordingly.

  • Now turning to slide ten, our Merchandise business sector reached its second highest quarter ever, at $1.35 billion up $124 million, or 10%, over the same period last year.

  • Volume fell 3% as lower auto production and continued weakness in manufacturing impacted shipments.

  • Revenue per unit reached a record $2,047, up $240, or 13%, over the first quarter last year.

  • Rate increases and higher fuel revenue drove this performance.

  • Within the Merchandise market segments, as shown on slide 11, Agriculture's revenue reached $299 million up $58 million, or 24%, over last year.

  • The 4% volume gain was driven by strong growth in ethanol to the southeast along with higher export grain and feed volumes due to the weak U.S.

  • dollar and high international demand for agricultural products.

  • Metals and construction revenue, as shown on slide 12, was up 11%, or $30 million, for the quarter.

  • Higher volume from new and an increased business in metals, machinery, and aggregates offset declines in housing-related commodities.

  • New coil steel business and increased intermill volumes helped offset weaker demand from the Detroit Three automotive manufacturers.

  • Aggregate shipments increased as our electrical utilities rubber stone network continues to ramp up, and growth in machinery was driven by export shipments from the Midwest over the ports of Baltimore and Savannah.

  • Turning to the next slide, chemical revenue reached a record $305 million, up $31 million despite a 3% decline in volume.

  • Continued pricing improvement and higher fuel drove the increase in revenue.

  • Volume declines were driven by lower plastics and feed stock carloads linked to housing construction declines.

  • Additionally, propane car loads dropped due to lower seasonal demand.

  • Now as shown in slide 14, our Forest products revenue of $215 million for the quarter exceeded first quarter last year by $4 million or 1%.

  • Volume decreases were driven by the decline in housing, lower volumes of paper, and delayed increases in waste shipments to selected disposal sites due to EPA and permitting issues.

  • These declines were partially offset by stronger export pulp board shipments.

  • Finally, automotive revenue, on the next slide, reached $228 million for the quarter.

  • Flat versus the same period last year despite a 10% decline in volume.

  • Rate increases and better fuel coverage applied in the second half of 2007 and renegotiation of a major parts contract in the first quarter of '08 drove the improvement in revenue.

  • Volume was negatively impacted by a reduction in North American vehicle production to 3.6 million units, which was down 9% compared with the first quarter of 2007.

  • This was coupled with the impact of the ongoing American Axle strike in Detroit.

  • Increases associated with BMW traffic in the U.S.

  • markets along with developing export vehicle traffic from domestic producers to Europe partially offset volume declines.

  • Now, turning to slide 16, despite the challenges in the current automotive market we continue to maintain the highest level of service to our automotive customers, which bodes well for business ahead.

  • During the quarter, Toyota, which holds its carriers to rigorous standards of performance, awarded Norfolk Southern with its 2007 President's Award for overall logistics excellence among rail carriers.

  • This is its highest recognition given to a logistics provider.

  • This award is based on overall customer service, on-time performance and quality.

  • We are pleased that this is the fifth President's Award that has been presented to Norfolk Southern since Toyota implemented its program in 1996 and we are proud to be a Toyota preferred carrier.

  • Now turning to slide 17, and concluding with our strongest performer for the quarter, coal revenue reached $662 million, up 19% over the first quarter of last year.

  • Revenue per unit increased $225 per car, or 17%, due primarily to pricing gains and higher fuel revenue.

  • Volume increased by 2% versus the same period last year, driven by strong export demand.

  • Reductions in the other market sectors stemmed primarily from coal availability and sourcing changes.

  • Turning to the individual coal markets on the next slide, export volume was up 64% over the first quarter last year and reached its highest carload volume since the second quarter of 1998.

  • Carloads through Lambert's Point increased by 16,000 units or 60%.

  • The dynamics of the export market continue to be in favor -- in our favor as U.S.

  • producers see increased demand for coal to Europe and Asia.

  • The weaker U.S.

  • dollar, along with tight worldwide coal supply, are driving this surge in demand.

  • With respect to domestic coal, utility volume in the northern half of our service network increased by 1,700 loads or 1%.

  • During the quarter, longer-haul, higher-rated spot movements were handled from the west due to higher demand and tight coal supply in our service territory.

  • But these gains were not offset -- enough to offset an 11,000 carload, or 7% decline, to southern-based utilities.

  • Volume in our domestic met coal market was 3% below first quarter last year.

  • Coal supply issues, due in part to the strong export market, reduced domestic metallurgical volume while coal sourcing drove the decline in coke shipments.

  • New shipments of domestic and import coke helped to offset part of this decline and industrial coal volume fell 20% driven by the shut down of the Wabash, Indiana mine and shipment delays due to coal sourcing and availability.

  • Turning to slide 19, looking ahead for the remaining three-quarters of the year, we will continue to face general softness in the housing and automotive sectors of the economy along with a lot of puts and takes in the other market sectors.

  • Despite this uncertainty, we expect coal volumes and revenues to be robust as export demand remains strong and domestic utilities move more aggressively to supplement stockpiles in the face of tighter coal supply.

  • Coal supply at Norfolk Southern-served mines will improve for the remaining three-quarters of this year as the reopening of CONSOL's Buchanan, Virginia, mine, the start up of Massey's new Mammoth operation this month near Charleston, West Virginia, and the first-quarter start of Trinity Coal's new mine in Page, West Virginia, all in combination will generate an additional 6.5 million tons of coal over the next three quarters versus the corresponding period of 2007.

  • In Intermodal and Merchandise, project growth is progressing as planned, which will bolster volumes over the remainder of the year.

  • Stronger exports throughout both sectors will supplement these project gains.

  • And with higher fuel prices combined with very solid service performance across our rail network, we believe truck-to-rail conversions should accelerate as the year progresses.

  • Finally, the pricing environment for our high-quality transportation service remains solid and we remain on track to realize a minimum 4% pure pricing improvement for the year as a whole.

  • Thank you very much.

  • Now I'll turn the mic over to Jim Squires who will present our financial report.

  • Jim Squires - CFO

  • Thank you, Don.

  • Good morning, everyone.

  • I'll now provide a review of our overall financial results for the first quarter.

  • Slide two, is a snapshot of our operating results.

  • As Don described, record Railway Operating revenues were up 11% from last year.

  • Operating expenses rose 12% resulting in a $50 million, or 9%, improvement in operating income.

  • The Railway Operating ratio for the quarter was 76.9 compared with 76.5 last year, an increase of 0.4 percentage points.

  • The next slide depicts first quarter operating results for the past five years.

  • As you can see 2008 was a record first quarter with a 9% increase in operating income, despite the effects of a legal settlement reached earlier this month.

  • Turning to our operating expense detail, slide four shows the year-over-year change by major expense category.

  • As you would expect the largest increase was in fuel, which rose $156 million, or 63%.

  • The next slide illustrates the components of the fuel increase.

  • Higher prices resulted in an additional $155 million of costs.

  • Our average price per gallon of diesel fuel was $2.79, a 65% increase compared with 2007 and there was a slight increase in consumption related to the mix of traffic.

  • Turning back to our expense categories, Materials and Other rose $26 million or 12%.

  • The two primary components are listed on the next slide.

  • As described in our April 7th press release, we reached a legal settlement related to the January 2005 Graniteville accident.

  • This settlement and offsetting favorable personal injury and environmental claims development combined to result in a $13 million year-over-year expense increase, which reduced diluted earnings per share by $0.02.

  • The other component of the increase was in materials costs which rose $12 million related to locomotive and car repair materials.

  • Nearly half of this increase was a direct result of higher prices for raw materials such as steel.

  • Additionally, while our internal usage of car repair materials is up, you will see in a couple of slides that we had fewer third-party car repairs.

  • The next largest expense increase was in Compensation and Benefits which rose $24 million or 4%.

  • Slide nine lists the two main reasons for the increase.

  • First, stock-based compensation rose $14 million due to this year's stock price increase, and the combination of a higher earn-out in 2008 and a lower earn-out in 2007.

  • Second, higher wage rates added $10 million to compensation costs.

  • Continuing on in our expense categories, the next slide shows the $9 million, or 2%, decrease in purchased services and rents.

  • This was due to lower equipment rents related to the decline in traffic volume and also to fewer third-party freight car repairs.

  • Now let's turn to our non-operating items.

  • As will you recall, the synthetic fuel tax credits expired at the end of 2007.

  • Therefore, we no longer have this expense as a component of non-operating items and we no longer have the tax benefit associated with these credits.

  • The second non-operating item with a significant variance is corporate-owned life insurance which decreased $21 million.

  • As you're aware, the underlying investment returns can be volatile in this area.

  • The $18 million net expense from corporate-owned life insurance this quarter resulted in a $0.04 reduction to diluted earnings per share.

  • And finally, interest income declined $10 million as a result of lower cash balances.

  • The combination of the $50 million increase in income from railway operations and a $6 million decrease in interest expense resulted in first-quarter income before taxes of $476 million, which was $56 million, or 13%, above last year.

  • Total income taxes for the quarter were $185 million compared with $135 million last year.

  • The higher effective tax rate of nearly 39%, compared with a rate of 32% in 2007, was driven primarily by the absent of the synthetic fuel tax credits.

  • As shown on slide 14, net income for the quarter was $291 million, an increase of $6 million, or 2%, compared with the $285 million earned in the first quarter of last year.

  • Diluted earnings per share for the quarter were $0.76, which was $0.05, or 7%, more than last year.

  • Turning to the next slide, you can see that these earnings resulted in strong cash flows for the quarter.

  • Operating cash flows exceeded $600 million and set a first-quarter record.

  • As depicted on slide 16, a portion of these strong cash flows was used to repurchase stock.

  • In the first quarter of 2008 we bought back 5.6 million shares for $276 million.

  • And this brings our total purchases since inception to 51 million shares at a cost of $2.4 billion.

  • Thank you for your attention.

  • And I will now turn the program back to Wick.

  • Wick Moorman - President

  • Thank you, Jim.

  • As you've heard, the first quarter was another very strong quarter for our company, even in the face of some economic head winds, substantially higher fuel prices and some unanticipated legal expenses.

  • It's worth noting that our operating ratio for the quarter would have been lower year-over-year but for those legal expenses.

  • Our results continue to showcase our superior service products and our ability to recognize value from those products, and they also show the strength of our balanced portfolio of businesses.

  • Before turning to your questions, let me talk a little more about our operations and service levels for the quarter.

  • Last quarter we discussed the composite performance measure that we've incorporated into our bonus calculation.

  • You will recall that it is comprised of three key internal performance measures -- how well we adhere to our thoroughbred operating plan, how well we do in making the right connections in our terminals, and the on-time performance of all of our trains measured within tight performance standards.

  • We put this measure into place in an effort to more closely align the interests of our employees in the field with the service goals of our company.

  • It's been in place since the first of the year, and we're already seeing the benefits of this approach in our operations.

  • For the first quarter, the composite metric improved 7% as compared to first quarter 2007 driven by improvement in all three of the internal performance metrics -- top adherence, connection performance, and train performance.

  • Practically, that means that we're doing an even better job of running our trains according to plan, moving cars more efficiently through our yards, and that our trains are running on time.

  • Not too early and not too late.

  • You can also see the results in our public performance metrics.

  • As you would expect, average terminal dwell time, which is directly correlated with these three metrics, has decreased year-over-year for the quarter.

  • Both average train speed and cars on-line improved as well.

  • You would expect to see cars on-line go down given lower volumes and better network connectivity, but the velocity improvement is particularly noteworthy given changes in the mix of trains that we're running.

  • As faster intermodal and automotive trains are rationalized due to softening demand, our average theoretical system velocity actually decreases and the effect is magnified by the addition of unit trains on the coal and grain side.

  • However, as Steve Tobias described at our last meeting, we're now in the process of scheduling our unit train network and the benefits in terms of asset velocity and utilization, not to mention improved customer service, are substantial with more to come.

  • Looking at the rest of 2008 we know that we'll be facing some challenging economic conditions.

  • Despite the fact that I spent a lot of time recently talking about whether railroads serve as the harbinger of the overall economy, I can tell that you my crystal ball is no better than any of yours.

  • However, the good news for all of us at Norfolk Southern is that the project-driven growth, which we discussed at our last meeting and Don just mentioned, is still in place and coming on-line, and we expect that the strength that we've seen in key parts of our business will continue.

  • In the current economic environment, we'll continue to operate our business in a prudent and nimble manner which will allow us to react as necessary to whatever the economy throws our way.

  • At the same time, we will not lose sight of or stop planning for the opportunities that will exist for us as the economy strengthens.

  • Thank you.

  • I will now turn the program over to the operator so that we can begin the Q&A session.

  • Operator

  • Thank you.

  • (OPERATOR INSTRUCTIONS) Our first question comes from Tom Wadewitz, with JP Morgan.

  • Please state your question.

  • Tom Wadewitz - Analyst

  • Ahead of time here I apologize if I'm asking something that you might have mentioned.

  • There was a little overlap in your call with another conference call going on.

  • In any case, on the pricing and the yield side, wanted to see if you could give a little further comment on what drove up the same store price.

  • I think you said it was 7%.

  • Then also if you could maybe give the breakdown in the total yield, the 13.9, between price fuel and whether there was any meaningful mix impact we should consider.

  • Don Seale - EVP - CMO

  • With respect to the last part of your question the mix was negligible in the quarter, so no impact to speak of from mix.

  • The yield of 7% was a timing issue with respect to increases that we took in the first quarter that will apply through subsequent quarters over the year.

  • Then, of course, the remainder was some of the index increases that were taken in existing contracts, which is part of an ongoing escalation in contracts that have been negotiated.

  • Tom Wadewitz - Analyst

  • So essentially it's -- of the 13.9 -- it's 7% price, 6.9% fuel?

  • That's the right way to look at it?

  • Don Seale - EVP - CMO

  • That's a good way to look at it.

  • Tom Wadewitz - Analyst

  • And you think the 7%, that continues at that level through the year -- you've got

  • Don Seale - EVP - CMO

  • Tom, as I mentioned, you might have missed the last comment that I made in my remarks.

  • Tom Wadewitz - Analyst

  • Right.

  • Don Seale - EVP - CMO

  • We feel we're on track as we mentioned to you in the fourth quarter of last year, we're on track for '08 to come in at a minimum of 4% for the year as a whole.

  • Tom Wadewitz - Analyst

  • So how do I resolve the difference between the -- you're expecting it to really tail off quite a bit later in the year, or is the 4% just a conservative number?

  • Because that's quite a bit below the 7% that you're talking about in first quarter.

  • Don Seale - EVP - CMO

  • As we've mentioned in the past, the quarters -- it's not ratable quarter to quarter.

  • We may have some quarters that are stronger, some quarters that are not, from a timing perspective.

  • But we're still comfortable with the minimum of 4% for the year as a whole, taking into account the timing as we go quarter to quarter.

  • Tom Wadewitz - Analyst

  • Okay.

  • And in terms of the impact of export coal, export coal prices obviously getting dramatic increase, and my understanding is you reprice the transport price for export coal on an annual basis starting April 1st.

  • Is there potential that we would see a further acceleration in your reported yields when we get into second quarter and when you've got the impact of export coal pricing coming in as well?

  • Don Seale - EVP - CMO

  • The export coal market is very dynamic, as I've discussed.

  • Most of our coal is in contract, which is confidential with respect to the terms, but you will continue to see us look at that very closely with respect to the demand equation and the supply equation with respect to transportation.

  • So, Tom, we will continue to move the needle on pricing with export coal, but I cannot comment beyond that because they're in contracts.

  • Tom Wadewitz - Analyst

  • I mean, without talking about a specific contract, is that logic that coal prices are up a lot, so you can take advantage and have some increase in your transport contract?

  • Is that a fair way to look at, or am I missing something?

  • Don Seale - EVP - CMO

  • I don't want to comment on our pricing strategy with respect to exports but you know the worldwide coal market is tight, and with the devaluation of the dollar we've got some very strong demand in Europe and in Asia for U.S.

  • coals.

  • And we're supporting that with our coal shippers and as we negotiate our contracts we take all of that into account because we do price to the market.

  • Tom Wadewitz - Analyst

  • Okay.

  • And the last one; I'll turn it over to someone else.

  • On the purchased services, there was some meaningful improvement as a percent of revenue in that line.

  • Again, I apologize if you already mentioned this, but can you tell us what the driver was and whether we should view that as an impact that would likely continue over the next couple quarters?

  • Jim Squires - CFO

  • Yes, Tom, this is Jim.

  • I'll cover that.

  • The biggest factor there in the combined purchased services and rents was, first, lower equipment rents, and then on the services side, we had fewer third-party freight car repairs.

  • That was offset by increased materials expense on the Materials and Others side.

  • And then in addition we had lower traffic volumes and there is a volume metric element to the purchase services as well, for example intermodal lifts.

  • That was the reason for the decrease there.

  • Don Seale - EVP - CMO

  • Tom to give you a little more color just on the freight car repair side and the materials side, we're looking across the year at freight car programs that are about the same as last year's.

  • We don't have any increases in them, but we do plan on maintaining the fleet.

  • We'll clearly have some inflation built into that.

  • As you heard, we saw some of in that in the first quarter.

  • So it will be a little bit -- it won't be purely ratable in terms of third-party repairs or material purchases, but we're looking at programs, particularly on the car side, that look about like last year's.

  • Tom Wadewitz - Analyst

  • Okay.

  • Good.

  • Well, thank you for the time.

  • Appreciate it.

  • Operator

  • Thank you.

  • Our next question comes from Ed Wolfe with Wolfe Research.

  • Please state your question.

  • Ed Wolfe - Analyst

  • Thanks.

  • Good morning, guys.

  • Wick Moorman - President

  • Good morning, Ed.

  • Ed Wolfe - Analyst

  • Couple things.

  • First, just a little bit more clarity on this 7% price in the quarter versus the guidance for 4%.

  • I just don't understand how, if you're getting pricing on that amount of your business right now, why that would change quarter-over-quarter so quickly.

  • Could you give just a little bit more flavor on that?

  • Don Seale - EVP - CMO

  • Good morning, Ed.

  • This is Don.

  • As you will recall in the fourth quarter, we had a 9% increase in RPU with 8% after backing out the item for automotive.

  • So basically, we've gone from 8% RPU to 14% RPU.

  • Fuel was higher, and fuel was about half of the 14% gain in RPU, and 7% pure price.

  • And the price was related to the timing of some coal repricing but also some repricing in automotive contracts that I mentioned in my prepared remarks; some other activities where the timing of those increases are applying and going forward.

  • Now, we may see -- we may see in subsequent quarters in the rest of the year where we will be above the 4% or we might be down comparable to it, but we're still comfortable with the overall minimum of four.

  • It could be a little higher than that, it could be close to being right on that number.

  • Ed Wolfe - Analyst

  • Don if you've got coal contracts that repriced in the first quarter, why wouldn't those stay repriced with the year-over-year comp and be up seven?

  • Don Seale - EVP - CMO

  • They will stay for the balance of the year, but we've got some other mix and some other activities that take place in the subsequent quarters that may not drive the number quite as high as 7% going forward.

  • Wick Moorman - President

  • Ed, you will recall that last year from quarter-to-quarter we had some variability in that.

  • And in fact, we had one quarter in which our underlying pricing seemed to be below 4%, and we got a lot of questions about that.

  • But we can't always give you a ratable number quarter-to-quarter, but I think we're comfortable with what we're saying right now.

  • That we may have a few ups and downs, but for the year, we're comfortable that we'll get a minimum of 4%.

  • And if economic conditions and the markets cooperate, hopefully we'll do better.

  • Ed Wolfe - Analyst

  • Thanks, Wick.

  • In terms of repricing of contracts in '08, can you go through how many contracts -- what percent of the contracts are going to reprice and which ones haven't repriced since '04, and if any of those took place in first quarter?

  • Don Seale - EVP - CMO

  • Yes, as we mentioned in the past, we've got about two-thirds of our total booked revenue under contract, about 67%/68%.

  • And the average duration of those contracts now are still in the range of three years, so we have approximately a third of those contracts that will be repriced each year.

  • The actual number for 2008 exactly, Ed, is 28% of our contracts.

  • Ed Wolfe - Analyst

  • And what percent of that 28 has repriced in the first quarter already, roughly?

  • Don Seale - EVP - CMO

  • We had, in the first quarter, about half of that 28%.

  • Ed Wolfe - Analyst

  • Jim, after four quarters of operating expenses, excluding fuel, being down we saw a 2% increase in first quarter (technical difficulty) the Graniteville settlement, were there any one -- unusual one-time costs in there?

  • How should we think about operating expenses going forward?

  • Don Seale - EVP - CMO

  • We highlighted the $0.02 from the legal settlement, net of favorability and claims.

  • Other operating expense changes in the quarter we would not characterize as unusual or one-off, but I think we expect to see a somewhat lower rate of increase in the materials expense column for the rest of the year.

  • We would expect to see, depending on volumes, continued favorability in purchased services and rents.

  • Now, in comp and benefits, the story there was twofold.

  • On the one hand we had a rise in our stock price in the quarter, and that affects the stock-based compensation piece of things.

  • And then in addition, we had higher earn-outs.

  • The adjustment to stock-based compensation accruals to reflect higher earn-outs and that was, again, really driven by the increase in our stock price in the quarter versus the benchmark S&P 500, upon which we base our total shareholder return component of long-term comp.

  • Then lastly we did have wage rate increases in the quarter, the majority of which were scheduled rate increases and that added to the compensation expense increase as well.

  • Ed Wolfe - Analyst

  • What was the stock-based comp impact in this --

  • Don Seale - EVP - CMO

  • I'm sorry?

  • Ed Wolfe - Analyst

  • What was the stock-based comp in dollars impact this quarter versus a year ago?

  • Don Seale - EVP - CMO

  • It was $14 million.

  • It went to $65 million from $51 million in the first quarter of 2007.

  • And that was a combination, as I mentioned, of earn-out and stock price increase, about 50/50, and then a small adjustment for other stock-based compensation.

  • Then we had $10 million increase in wage rates.

  • Ed Wolfe - Analyst

  • Is 39% as good as any for a tax rate going forward?

  • Don Seale - EVP - CMO

  • Well, I think we're going to see an effective rate throughout the year in the high 30s.

  • Probably 38/39, somewhere in that vicinity for the rest of the year would be our expectation.

  • Ed Wolfe - Analyst

  • The $18 million, the corporate-owned life insurance, that's a one-time event or does some of that carry forward?

  • Don Seale - EVP - CMO

  • What you saw there were changes in the value of marketable securities which constitute the underlying COLI investments.

  • Those have to be mark-to-market each quarter.

  • Because in the quarter we saw a 5% -- roughly 5% decline in the value of the COLI investments, that along with some other adjustments in the COLI net number created the unfavorable variance.

  • And it is a volatile item because of the mark-to-market accounting for it.

  • If you look back, it has fluctuated over the years.

  • Wick Moorman - President

  • It's a little bigger fluctuation in the first quarter than normal.

  • And another thing, and this has a slight effect on the tax rate, is that it does not have a tax shield.

  • So we are accustomed to seeing a little movement every year, or every quarter in the COLI, depending on what underlying securities do.

  • This one was larger than we're accustomed to seeing, but we don't expect -- we don't know what the markets will do in general, but this is certainly not something we are expecting to see own a continuing basis.

  • Jim Squires - CFO

  • The other moving part in other income net was the lower interest income as well, that declined $10 million.

  • That is a reflection of much lower cash balances this year than we had at this time last year.

  • Ed Wolfe - Analyst

  • One last question for Don.

  • On the coal side, how sustainable is the 64% growth in export coal?

  • You're on a run rate, I think, of 23 million tons.

  • Don Seale - EVP - CMO

  • Ed, obviously demand, where the dollar is, coal supply is a big part of this as well.

  • We've handled more coal than this obviously in the past, and we've got the capacity at our pier -- at pier 6 and pier 5, at Lambert's Point -- to ramp up additional capacity.

  • At one point we handled as much as 40 million tons over that.

  • But it's a function of where the dollar is, where other international production is, namely the Australians, South Americans, as well as the Russians, and then just the overall ongoing demand.

  • I don't anticipate that run rate continuing into the future because, obviously, we have some coal supply constraints that I don't believe will support that type of volume increase.

  • Ed Wolfe - Analyst

  • The big question, assuming the demand is there, do you think the supply chain can handle -- how much can they handle, do you think?

  • Not just you but the whole --

  • Don Seale - EVP - CMO

  • I'm comfortable with the supply chain with respect to our capabilities and our port capacity.

  • Obviously, we would have to ramp up some additional capacity that's been mothballed, but we have that capability of doing that.

  • I don't know if you saw The New York Times this morning, Ed, but the front page has -- the head line is 50 additional new coal-fired utility plants being built in Europe because of concern of shortfalls in electrical generation capability and the fact that natural gas is now deemed to be less dependable and very, very expensive in Europe.

  • So that's somewhat of a change when we see that type of activity that's being documented.

  • So we could see demand in Europe for U.S.

  • coal on the steam side, as well as the metallurgical side for steel making, change and we're in the midst of that change right now.

  • Ed Wolfe - Analyst

  • I thank all of you for all your time.

  • Thank you.

  • It's all very helpful.

  • Don Seale - EVP - CMO

  • Thank you, Ed.

  • Operator

  • Thank you.

  • Our next question comes from John Barnes with BB&T Capital Markets.

  • Please state your question.

  • John Barnes - Analyst

  • Good morning, guys.

  • Wick, I mean, you guys did a phenomenal job on the cost side.

  • Only 40 basis points of OR degradation year-over-year when you had fuel go up at the pace it did.

  • I'm curious, as to -- as volumes begin to rebound, and these are models that have always done a little bit better when you're pushing a little bit more volume through the system.

  • And I guess -- I don't mean to be long-winded -- but the knock on the Company had been you kind of reached a low 70s OR.

  • And it seemed like that was always the hurdle, it was tough to get through and get lower than that 72/71.5, somewhere in that ballpark.

  • Do you feel like the cost that you took out this quarter and your ability to really perform well on the margin side in the face of higher fuel costs translates into a much lower OR as volumes begin to recover?

  • Can we see something in a better economy?

  • Can we see a high 60s OR at Norfolk?

  • Don Seale - EVP - CMO

  • Well, John, you know how we have stayed focused on our OR for a long time in this company.

  • And I think you've put your finger on an important point.

  • As we have improved our service, added physical capacity to the network and really brought our assets up to a level of maintenance that allows us to provide the service we do, we think that we have the ability now, as volumes continue to -- as volumes come back and grow, to add additional services and services at a high level without a significant impact in our cost structure.

  • And I think that sets the stage, that kind of operating leverage sets the stage, as our growth resumes.

  • And economic conditions, as Don pointed out, may drive traffic to the rails even before the rest of the economy starts to come back.

  • And that's going to allow us -- we hope and plan to do some significant things with our operating ratio.

  • It's tougher the lower you get.

  • There's just no question about that.

  • But we haven't lost sight of that, and, you know, I will tell you, our goal is to have an operating ratio with a 6 in front of it.

  • We're going to keep working hard to get to that goal.

  • I think that we have got the Company, and Steve and his folks have gotten our operations into a very good place to do that.

  • John Barnes - Analyst

  • Okay.

  • Very good.

  • In terms of some of the market opportunities that are out there, there's export coal, and I think I read someplace they're starting to put a fair amount of investment back into things like Lambert's Point again.

  • How do you balance -- export coal looks real attractive right now given the dynamics in the marketplace, weak U.S.

  • dollar, things like that.

  • But how do you balance making the necessary investments to support things like export coal where you just you don't have a good read into it longer term?

  • I think at the peak you all were -- what at the peak you were doing twice or maybe three times as much export coal as you're doing today, or a year ago?

  • So how do you balance making those CapEx decisions out with some uncertainty as to what the long-term benefit could be?

  • Wick Moorman - President

  • Well, that's a great question.

  • If you look at our facility, and you're right, we peaked out through Lambert's Point at something north of 40 million tons a year.

  • It's still a great facility.

  • It's in a very good state of repair and we can add capacity there, as Don said, very easily.

  • It's really more a question of kind of ramping up the train service and the crews and the facility rather than having to make significant investments in CapEx.

  • Having said that, we still to have make some investment.

  • We still have to plan ahead.

  • We still to have think about hiring.

  • But one of the things that we've been trying -- Don and his team have been trying to do is to really get a handle on what's this export market look like for the longer term.

  • And I have to say that what we're hearing from a lot of folks in the coal industry is that this is going to be with us for awhile.

  • And what they're looking at are things like the new coal plants being built in Europe.

  • They're looking at the fact that China is not exporting coal any more, as are a couple of other formerly coal exporting nations.

  • They're looking at the issues -- and these may be shorter term, but they've been there for awhile -- with getting some of the Australian coal out of Australia.

  • And they're also looking at things like bulk-shipping rates.

  • So the more we go into this export boom, the more we think that this really has the legs for not just one or two years, but for multiple years.

  • And that will help us as we think about investing.

  • John Barnes - Analyst

  • Okay, very good.

  • Guys, nice quarter.

  • Thank you for your time.

  • Operator

  • Our next question comes from William Greene with Morgan Stanley.

  • Please state your question.

  • William Greene - Analyst

  • Don, I'm sorry to bring this up one more time, but just in terms of the pricing, is it that you have some fuel rebasing in there as well?

  • Don Seale - EVP - CMO

  • In terms of the 7% that I mentioned, it is pure price.

  • William Greene - Analyst

  • Okay.

  • And then with regard to utility stockpiles in your region, how do they look at this point?

  • Wick Moorman - President

  • Bill, could you repeat that, please?

  • I didn't catch it.

  • William Greene - Analyst

  • Oh, sorry.

  • I said in terms of utility stockpiles in your region, how do they look?

  • Wick Moorman - President

  • We've got the northern utilities that generally the stockpiles are lower, and as I mentioned in the remarks, that business was up in the first quarter.

  • We even moved some traffic, some coal from the west to supplement coal supply.

  • In the south, utility stockpiles have been higher.

  • But I can tell you that you we have information that those are beginning to come down.

  • And we have some indications that those utilities are coming into the market seeking coal fairly aggressively, because coal supply later this year could be a very real issue for all utilities as they work to replenish stockpiles.

  • So I think we're beginning to see the northern utilities work hard to replenish already lower stockpiles, and our southern utilities take a more aggressive approach to seeking sourcing to start replenishing theirs.

  • William Greene - Analyst

  • In terms of, if you exclude coal, and you look at the merchandise and automotive traffic and whatnot, what gives you confidence that you can actually grow volumes for the remainder of the year?

  • Because it seems to me that a lot of your other freight compatriots are suggesting this will be tough given the economic environment.

  • Wick Moorman - President

  • Well, it starts, Bill, with our projects that are coming on stream.

  • We mentioned those specific projects that we have in our budget, which we know will generate business.

  • But we're also seeing, even in April, our volumes trend upward.

  • We're up about 1%.

  • Intermodal has trended positive.

  • We've got some positive indicators on the steel market.

  • Business is still up year-over-year.

  • Our Aggregates business, I mentioned the scrubber stone going to utility plants, that's ramping up.

  • So we've got new project driven volumes that are in the network that we feel will generate the type of year-over-year growth that we're talking about.

  • And then the wildcard here is the conversion from highway, taking into account $4.25 diesel costs on highway.

  • And we're seeing some of our intermodal truckload segments within the eastern half of our market in particular -- and this is the intermodal service back in single-line NS within the east -- beginning to get traction with respect to new business that's being converted from highway to rail.

  • So you put all that together, and we still see some up-lift in volume this year.

  • William Greene - Analyst

  • How far below do you think your intermodal rates are versus the road?

  • Wick Moorman - President

  • That is a moving target, Bill, as you know, because as truck costs move that gap widens.

  • So it varies depending upon market segment.

  • That's something we're watching very carefully, and we're going to continue to price our Intermodal service to that market.

  • William Greene - Analyst

  • Thank you for your help.

  • Operator

  • Our next question comes from Ken Hoexter with Merrill Lynch.

  • Please state your question.

  • Ken Hoexter - Analyst

  • Good morning.

  • You did a great job on controlling costs this quarter.

  • Just want to understand, you've lowered your employee counts now two quarters in a row.

  • Can you talk about what you target as far as continuing that trend?

  • Wick Moorman - President

  • Yes, good morning, Ken.

  • The employee counts have come down a little bit.

  • We're watching that very carefully.

  • As we've discussed before, we have a significant attrition issue facing us over the next few years due to the demographics of our workforce.

  • And we have been hiring aggressively, as you know, for awhile.

  • But we have some very good models which take traffic levels into account, and as we've seen traffic soften, we've really started to moderate on our hiring and work that into our plans.

  • If you actually look at our numbers year-over-year, they would be even lower were it not for the fact that our numbers are up on our non-agreement side, our management side, because we've brought in a significant number of management trainees year-over-year.

  • And I think that's a smart thing for us to do.

  • I think looking forward in the year, depending again on traffic levels, we hope that we'll see the numbers continue to moderate, but moderate slightly.

  • We don't think we're oversized right now.

  • And we're trying to make sure that we've got the right number of people to run the trains and have enough people to run them on time, and that's the way we're going to continue to manage.

  • Ken Hoexter - Analyst

  • Jumping over to your fuel surcharge for a second, can you talk a bit about -- with the change to the mileage-based program, I know that was for a small part, but -- .

  • And then on the core fuel surcharge, how much is WTI versus an on-highway diesel-based

  • Don Seale - EVP - CMO

  • Ken, as you might know, we have no fuel surcharge in place on our public prices.

  • Everything else is in contract, and I cannot talk about the structure of what we have in our contracts because of the confidentiality.

  • But on all of our originated public prices, we are using market-based pricing to cover the -- all of the components of our costs, plus the market.

  • Ken Hoexter - Analyst

  • So you can't even tell me -- ?

  • I'm not asking a specific contract in general.

  • You can't just say if most of your contracts are based on WTI or -- in other words, are you exposed to crack

  • Don Seale - EVP - CMO

  • In terms of our basic proxy that we're using, we continue to use West Texas Intermediate crude oil.

  • Ken Hoexter - Analyst

  • So then you are exposed to crack spreads as they've widened.

  • Don Seale - EVP - CMO

  • Yes.

  • Ken Hoexter - Analyst

  • Okay.

  • Great, thank you very much.

  • Operator

  • Our next question comes from David Feinberg with Goldman Sachs.

  • Please state your question.

  • David Feinberg - Analyst

  • Good morning, gentlemen.

  • I think you touched on this earlier, but I just wanted to make sure I covered -- with regard to your Intermodal and Merchandise business where you talked about the outlook for the rest of the year relying on projects coming on stream.

  • One of the answers to the earlier questions you mentioned -- steel and scrubber stone -- was there anything else we should bear in mind as we look throughout the year?

  • Wick Moorman - President

  • Certainly I mentioned exports, and exports we're continuing to see some new business opportunities emerge from that almost monthly.

  • We're seeing new finished vehicles produced in the U.S.

  • being exported to Eastern Europe, and the market is growing in Eastern Europe with respect to that demand.

  • Machinery is another commodity that we're seeing very, very strong demand in Europe for exports, and we're participating in that.

  • So the exports in general, I think for Intermodal as well as the Merchandise car load business, we're -- another commodity that I haven't talked about is grain in containers that are being exported over East Coast ports.

  • That's another growth opportunity.

  • David Feinberg - Analyst

  • And in order to see that come through is that just existing business that will be shifting or do we actually need to see a change in your facility or things like Rickenbacher coming on line?

  • Wick Moorman - President

  • No, actually we have a lot of the infrastructure already in place that enables us to participate in these projects.

  • The scrubber stone is a good example.

  • We had the equipment generally is private equipment that's leased by a private supplier, not leased by Norfolk Southern.

  • So those arrangements are already in place.

  • Certainly as we open new facilities, like Rickenbacher, it will have a positive impact with respect to our capacity and our ability to grow intermodal traffic in the Ohio Valley.

  • So those types of projects, which are in our plan, as we open those it enables to us handle more volume.

  • David Feinberg - Analyst

  • Great.

  • Then one follow-up question with regards to the legal settlement.

  • I imagine in any given quarter you have a whole host of legal settlements that you may or may not be making.

  • As we look forward are there any other larger cases that are pending that we should keep an eye on that may affect results as they did this quarter?

  • Wick Moorman - President

  • We wouldn't anticipate anything of the magnitude of the Graniteville issues.

  • You never know, but on a regular run rate basis we don't see these kinds of things.

  • David Feinberg - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • There are no further questions at this time.

  • I will turn the conference back over to Mr.

  • Moorman for closing comments.

  • Wick Moorman - President

  • Well, thank you very much, everyone, for listening in.

  • We appreciate all of your questions, and we look forward to talking to you again in the near future.

  • Thanks.

  • Operator

  • Thank you.

  • This concludes today's teleconference.

  • You may disconnect your lines at this time.

  • Thank you all for your participation.