Norfolk Southern Corp (NSC) 2008 Q2 法說會逐字稿

Welcome to the Norfolk Southern Corporation second quarter earnings conference call.

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

A brief question and answer session will follow the presentation.

(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 Ms.

Marilley, you may begin.

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 second 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 investors' 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 key pad.

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 use of the words such as believe, expect, anticipate and project.

Our results may differ materially from those projected, and will be subject to a number of risks and uncertainties,s 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.

Thank you, Leanne, and good morning to everyone.

It is also my privilege to welcome all of you to our second quarter 2008 analyst conference call.

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

We are also joined by Rob Kesler, our Vice President of Taxation; Bill Romig, Vice President and Treasurer; and Marta Stewart, our Vice President and Controller.

When we last met I indicated that we were optimistic that the momentum that we had demonstrated in the first three months of the year would continue into the second quarter, and I'm very pleased to report that Norfolk Southern delivered strong top line growth, profitability and bottom line results and set a number of financial and operational records this quarter.

First, railway operating revenues were the highest in our history, up 16% over last year.

Second, we posted our best ever income from railway operations, also up 16%.

Third, net income was a record $453 million, or $1.18 per diluted share, up 15% over the comparable period last year.

And perhaps most importantly, our performance metrics, the catalyst driving these record results, continued to improve and remain among the best in the industry.

By any measure, this was an extremely strong quarter for our company.

Despite ongoing weakness in the automotive and housing sectors of the economy and unprecedented high fuel prices, we improved revenue per unit and maintained our strong pricing and service performance, a real testament to our people who continue to make the extra effort to keep service levels, high even in the wake of the weather challenges we saw in the second quarter.

As you may recall we implemented a new composite performance measurement that is part of our compensation calculations.

Since its introduction at the first of the year, this measurement has sharpened our operational focus by measuring how well we adhere to our thoroughbred operating plan, how well we do at making the right connections in our terminals, and the on time performance of all of our trains measured within tight standards.

And notwithstanding the near-term impact of the Midwest flooding in our performance, I'm happy to say that we're seeing both year-over-year and sequential improvements in these measurements.

As a result we clearly continue to benefit from value-based pricing,commensurate with our strong service levels, and demand for our business is increasing as we strategically expand our portfolio of service offerings in response to a changing marketplace.

We continually strive to improve our service performance through intensive focus on all of our assets, our people, infrastructure, information, and equipment.

In that regard, our board yesterday authorized an additional $80 million in capital spending this year for new locomotives and rail replacement work.

The rail replacement will give us a tax advantaged head start on next year's program, and the additional power also tax advantaged, which we expect to take delivery of in the fourth quarter, should help improve fuel efficiency and service performance particularly in our dedicated unit train network.

As a further indication that Norfolk Southern is on the right strategic track, our board also increased our dividend by $0.03 per share or 10% yesterday, resulting in an annualized dividend of $1.28 per share.

As you will recall, we also increased our dividend 12% in January, and we have more than tripled the dividend in the past three years.

As a part of our balanced financial strategy, our goal is to achieve about a one-third payout ratio.

Overall, we remain optimistic about the future, and we are planning and investing accordingly.

We are confident that our franchise will continue to benefit from a broad and balanced portfolio of businesses, as well as from rail's inherent advantages, safety and reliability, fuel efficiency and environmental sustainability.

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

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

Thank you Wick, and good morning everyone.

As we enter the second year of this challenging economic cycle, revenue growth from our diverse base of business continues to outpace the economy, and as Wick mentioned I'm pleased to report another record performance.

During the second quarter, we generated $2.8 billion in revenue, an increase of $387 million, or 16%, over the same period of 2007, with new records in each of our major sectors.

Coal revenues were up 34%.

Intermodal was up 11%, and merchandise revenue grew by 10%.

Our revenue gains continue to be driven by strong market-based pricing, increased fuel surcharge revenue, and our high quality service product.

With respect to yield, as shown on slide three, the second quarter represented our 23rd consecutive quarter of revenue per unit growth,.

With the exception of automotive, six of seven business segments record revenue per unit, generating an all-time high of $1,455 for the quarter.

Of the 19% RPU growth in the quarter, roughly half was due to price, and the other half, higher fuel surcharge revenue.

As I indicated to you last year and during the first quarter report, we are seeing higher repricing activity and results for coal and Intermodal than we saw last year, along with continuing repricing opportunity in merchandise.

Obviously we are exceeding the minimum 4% pricing target that we set earlier this year, and we expect that favorable trend to continue for the balance of the year.

It is worth noting that we have established a longer term trend of improved revenue per unit growth dating back to 2002.

Slide four illustrates that, since the second quarter of 2002 total revenue per unit has grown by 57%.

We have made a concerted effort to realize the proper value of our high quality service product especially after the introduction of our Thoroughbred Operating Plan in 2001.

Infrastructure improvements to our network in the form of new terminals and higher capacity cars have also contributed to our RPU gain.

In addition we have broadened our fuel surcharge coverage, which currently stands at 94% of total revenues, excluding revenue for public rate authorities.

Traffic mix has also impacted RPU both positively and negatively over this period of time.

Longer haul traffic has benefited some of our carload commodities, while the increase in international intermodal volume has somewhat tempered growth in intermodal RPU, as higher margin, lower-rated containers have grown at a faster pace than trailers.

We have also established a strong trend of growing our volumes over the same period of time as shown in slide five.

Comparing the second quarter of 2008, indexed to 2002, volume over our network has increased by 18%, versus a 7% increase in industrial production, minus technology and services.

And notably, our growth trend has exceeded the 4% gain in truck tonnage over the same period.

Turning to slide six and back to the second quarter, it is also notable how our diverse portfolio of business and project-driven growth worked to offset some of the weaknesses in housing-related commodities and the automotive sector.

Agricultural volumes set another quarterly record, which increased metal shipments were strong driven by pipe, plate, and coil steel shipments.

Export coal continued to be the strongest performer in the quarter, increasing 63%.

Declines in auto parts, SUVs, and trucks accounted for the 30,000 carload decrease in automotive, which represented three quarters of our total net volume decline in the quarter.

Housing related commodities, such as lumber, plywood, appliances, insulation, and roofing materials accounted for a decline of 16,000 loads.

Excluding auto and housing losses, our remaining book of business increased by some 5,400 loads during the period.

As shown in slide seven, we also continue to see the affects of changing trade patterns in our overall business.

The outlook for the domestic economy remains weak in the near term, but we continue to see stronger export demand.

Accordingly, we have been experiencing gains in export, such as coal, grains, scrap metal, and machinery, and a corresponding decline in imported slab steel and consumer goods related to housing.

Across all commodities during the quarter we saw an 11% decline in total import volume, which was off set by a 14% gain in export traffic.

Now turning to the highlights of our individual markets during the quarter as shown on slide eight, Coal revenue of $775 million was up 34% over the second quarter of last year, and up 17% over the record revenue posted in the first quarter of this year.

The 3% gain in volume was driven by increased export coal and higher utility volumes to our northern-based utilities.

Revenue per car reached a record of $1,729, driven by re-priced contracts, stronger contract escalation, and higher fuel surcharge revenue.

The substantial increase in longer haul export also boosted RPU.

The average length of haul for export coal in the quarter was 441 miles, compared to 280 miles for our utility coal book of business.

Within the coal segments, as shown on slide nine, Coal's major story continues to be export.

The dynamics of the export market continue to be in our favor, as increased global demand, the lower U.S.

dollar, and tighter worldwide coal supply, are all driving U.S.

metallurgical and steam coals to Europe at a very robust pace.

Slide 10 shows our Lambert's Point Export Coal Pier, where volume increased 56% for the quarter.

We are projecting to move 20 million tons over this terminal during the year, which is about half of the facility's capacity.

We certainly have available rail equipment and port capacity to handle a significantly higher volume of export tonnage, if the coal supply and orders are there to take it.

Looking at our remaining coal segments on slide 11, the utility market was down less than 1% in car loads in the quarter, with a slight increase in tonnage due to higher capacity cars.

Utility volume growth was impacted by widespread Midwest flooding in June which curtailed the growth of western PRB shipments moving to NS destinations.

In addition, competition with export buyers for available coal supply suppressed volume comparisons in the quarter.

Volumes for southern utilities declined by 5%, while our volume to our northern utilities grew by 3%.

With respect to the latter, we realized a 19% increase in coal volume diverted from truck to the Keystone Plant in Shelocta, Pennsylvania, as a result of a new contract over our new more direct rail service to that plant.

Domestic met shipments fell 6% in the second quarter, as volume was negatively impacted by constrained coal supply due to strong export demand.

Within the domestic met market, coke volume was up 8%, and iron ore volume increased 17%, while industrial coal was down 15% in the quarter, due again to higher coal prices and competition from export coal demand within this segment.

Now, turning to slide 12 and our Intermodal market, record revenue in Intermodal in the quarter of $532 million was up 11%, versus second quarter 2007, as volume declined 3%.

Revenue per unit was up 14%, principally driven by increased fuel surcharge revenue, combined with pricing gains, and a positive change this traffic mix.

Positive mix was drive by an increase in domestic traffic, conversion of Ocean Carrier revenue empty moves into loads as a result of export growth, and longer haul Triple Crown services traffic.

Looking at the individual markets in Intermodal on slide 13, after several quarters of posting year-over-year declines, domestic Intermodal volume increased 7% in the second quarter.

As we lapped the 2007 loss of JB Hunt traffic to Atlanta, and Schneider volumes in the Northeast, we saw the pace of domestic increases accelerate within our local eastern network during the quarter.

For example, in the past month, our total domestic business has jumped by 13%, and domestic volume solely within our eastern network, our local eastern network, is up by 20%.

We expect higher fuel costs, tighter ISO container availability, and collaborative truck-to-rail conversions with our truckload partners will continue to drive this favorable trend for the balance of the year.

Our premium Intermodal business, which includes parcel and less-than-truckload, LTL, carriers, was down 6%, as LTL conversions form the highway partially offset reduced private empty trailer repositioning and softer parcel volumes.

Triple Crown Services volume was down 1%, partially driven by the impact of American Axle's strike in the auto industry.

And international volume decreased 8% for the quarter, driven by lower consumer spending on import goods, associated primarily with the weak housing market.

As shown on slide 14, with respect to the continuing story of shifting trade patterns over the various ports, we saw deeper declines in our second quarter volumes moving over the West Coast ports, which were down 17%, as compared to a 6% gain, through East Coast ports.

As a result, approximately 54% of our port business is now moving through East Coast ports compared to 46% through the West.

Another ongoing trend is the shortage of containers for export from the U.S.

Containerized exports are facing problems due to a lack of equipment at inland locations and lack of vessel capacity.

And, as in the first quarter, we continued to see the declines in the revenue movement of empty containers back to port locations.

During the quarter, empty revenue movements in containers declined by 14,000 units, as lower volumes of imported containers and higher export demand worked in tandem to reduce empty repositioning needs.

Finally, concluding with our Merchandise business as depicted in slide 15, we achieved total revenue of $1.46 billion in merchandise up 10% over second quarter last year, in the face of an overall volume decline of 5%.

Strong pricing growth was the principal driver in revenue and revenue per car gains.

Fuel surcharge revenue also contributed to the increase.

Record Agricultural revenue in shipments were driven by continued growth in ethanol, which was up 20% primarily to the Southeastern market.

Export corn and feed shipments, coupled with new business, also contributed to these gains.

Metals and Construction growth resulted from strong global demand driving higher export scrap and domestic steel demand.

Increases in Metals offset the declines in construction materials related to the housing market.

Chemicals revenue improved in the quarter despite declines across the major market segments.

Losses resulting from plant closures accounted for 25% of the decline in the Chemical sector.

The lower demand for construction and paving materials also contributed to the decline.

Finally, the weak housing market continues to impact our Paper and Forest Product sector.

A 25% decline in lumber and construction related materials was partially off set by a 12% gain in export pulp board.

As noted on slide 16 the transitioning of the automotive industry continues to impact our results.

During the quarter, Automotive volume fell by 21%, while revenue declined by 11%.

Volume was impacted by a 15% reduction in North American light vehicle production, which included the affects of the American Axle strike that carried over into the second quarter.

And the second quarter 2007 closure of Ford's Norfolk and Wixom, Michigan plants also impacted volumes in the quarter, which we finally lapped in late June.

Partially off setting these domestic declines, Toyota Camry volume at the Lafayette, Indiana plant was up for the quarter, along with stronger volumes from Honda's Ohio and Alabama plants.

Increased production at BMW's assembly plant in South Carolina also had a positive impact on carloads driven by the full ramp-up of its most recent plan expansion.

But as we all know, further plant and production rationalization in the auto industry has been announced.

Slide 17 depicts announced closures and ship productions for the Big Three and the impact on our traffic for the next year.

As you would suspect, we have been reducing train starts and related network expenses associated with current volume declines in the automotive network, and we plan to continue that same approach as these additional production cuts take place.

Of course, a portion of the projected 39,000 carload reduction depicted here will be offset by volumes from new assembly plant production.

And in that regard, we are very pleased that last week, on July 15th, Volkswagon announced plans to construct a new auto assembly plant along our main line in Chattanooga, Tennessee.

This 2011 project will continue to build upon the new assembly capacity that Norfolk Southern serves.

As we look ahead over the next two quarters in the final slide, we will face continued headwinds in the automotive and housing sectors.

With respect to housing, its effects are pervasive, impacting both domestic movements as well as imported furniture and associated products moving in inbound containers.

And as I just reviewed, Automotive will continue to be a challenge for several quarters to come.

On the plus side, we expect further volume and revenue gains in Metals, Agricultural products, Coal, and domestic Intermodal shipments over the balance of 2008.

Also as stated in my first quarter report, we will continue to realize the benefit of improved coal supply in central Appalachia.

Higher production this year is being driven by the resumption of mining at Consol's Buchanan Mine, along with two additional mines that ramped up in West Virginia earlier this year.

Much of this coal is destined to Europe, and we expect export activity to continue to drive substantial growth in coal volumes and revenue for the remainder of this year and into 2009.

We also expect utility coal to both our Northern and Southern based utilities to increase over the months ahead, as stockpiles are rebuilt into the fall and winter heating seasons.

In the Intermodal market, we expect domestic Intermodal volume to increase over the balance of the year, as higher fuel costs and greater terminal capacity, such as our new Rickenbacker Logistics Center in Columbus, and our solid service product, all help to drive conversions of freight from the highway.

And last, but certainly not least, we fully expect the favorable pricing environment for our high quality transportation service to continue into the foreseeable future.

With pricing results of 7% and 9% respectively in the first two quarters of the year, we expect a similar range of pricing yield over the final two quarters of 2008.

Thank you for your attention and now I will turn the program over to Jim for our financial report.

Thank you, Don.

I will now provide a review of our overall financial results for the second quarter.

Slide two is a snapshot of our operating results.

As Don described record railway operating revenues were up 16% over last year.

Operating expenses also rose by 16%, resulting in record breaking railway profitability of $799 million for the quarter.

The operating ratio was comparable to last year's.

Slide three shows the year-over-year change by major expense category.

As you would expect, the largest increase was in fuel which rose $212 million or 76%.

The next slide illustrates the components of the fuel increase.

Higher prices resulted in an additional $216 million of expenses.

Our average price per gallon of diesel fuel was $3.58, an 81% increase compared with 2007.

The decline in traffic volume resulted in a $4 million reduction in consumption.

The next largest expense increase was in compensation and benefits which rose $33 million or 5%.

Slide six lists the reasons for the increase.

Incentive compensation, which covers non-union employees, as well as locomotive engineers and dispatcher,s rose by $19 million due to a higher projected payout.

Secondly, stock based compensation added $13 million, primarily due to a stock price increase of over $8 during the quarter.

Pay roll taxes had a $9 million comparative headwind due to a favorable settlement in the second quarter of 2007.

Other items resulted in a net decrease of $8 million.

Continuing on in our expense categories, the next slide highlights the $20 million or 5% increase in purchase services and rents.

This increase was driven by a variety of small items, including rising Intermodal terminal costs, higher roadway repair costs and increased professional and legal services.

These were somewhat offset by lower equipment rents.

Materials and other expenses rose $6 million or 3%, as a result of higher costs associated with derailments and material for locomotive and freight car repairs.

These amounts were partially off set by favorable personal injury claims development and lower environmental costs.

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

First, synthetic fuel investments, the tax benefits for which expired at the end of 2007, contributed $26 million to the change.

Second, corporate owned life insurance decreased $11 million, including higher borrowings and lower returns under the program.

Third, interest on tax deficiencies contributed $9 million to the change.

Fourth, as you have seen in recent quarters, our interest income is down $7 million, primarily due to lower rates.

And finally, gains on property sales were $5 million higher this quarter.

Turning to the next slide, the combination of the $109 million increase in income from railway operations and the 25 million increase in other income, resulted in a record $733 million of income before income taxes, which is 22% above last year.

Total income taxes for the quarter were $280 million compared, with $206 million last year.

The higher effective tax rate of 38.2%, compared with the rate of 34.3% in 2007, was driven primarily by the absence of the synthetic fuel tax credits.

As shown on slide 12, net income for the quarter was a record $453 million, an increase of $59 million or 15%, compared with the $394 million earned in the second quarter of last year.

Diluted earnings per share for the quarter was a record $1.18, which was $0.20 or 20% more than last year.

Slide 13 provides an update on our share repurchase program.

In the second quarter of 2008 we bought back 3.4 million shares for $218 million.

This brings our total repurchases since inception to 54.4 million shares at a cost of $2.7 billion.

Thank you for your attention and now I will turn the program back to Wick.

Thank you, Jim.

Well, as you have heard, this was an exceptional quarter for our company even in the face of some economic headwinds.

Turning to the balance of the year, as we have said before, the economy continues to be clearly softer than we had originally anticipated.

However, we do expect that our balance business portfolio and superior service offerings will continue to help offset declines in our businesses related to the housing and automotive sectors of the economy, and in fact, we believe that our volumes will increase on a year-over-year basis for the second half, as evidenced by our gains to date in July.

As you have heard, we are seeing continuing strength in Coal, particularly on the export side, Ag and Metals, with softness in Construction, Paper and Forest products, Chemicals and Automotives.

While Intermodal volumes are down slightly, year over year, the import volumes seem to have stabilized, exports are growing and the domestic side has really begun to accelerate as higher and higher diesel prices make truck-to-rail conversion more and more compelling.

Also, as we've discussed before, project-driven growth in our Intermodal and general merchandise markets is progressing as planned, which should bolster volumes over the remainder of the year.

Summing it all up, as I have stated before, we remain optimistic about the future.

The macro trends that have benefited us are clearly continuing.

First systemically high fuel prices, which are now to the point that companies are beginning to re-evaluate their supply chains and manufacturing bases, with an increasing emphasis on rail transportation.

Second, as Don outlined, a continued shift of import and export traffic from the West Coast ports and to the East Coast ports, and finally, an ever increasing emphasis on environmental and sustainability issues.

We believe that Norfolk Southern is particularly well situated to take advantage of these trends.

We are working hard to strengthen our franchise through initiatives like the Heartland, Patriot, and Crescent corridors, as well as our constant focus on safety, service excellence, and sustainability.

We are thinking in terms about where our business will be not just in the near term, but in five years, ten years or even longer.

Clearly we are working in a lot of different areas to keep our business moving on the fast track, as we strategically navigate a rapidly changing landscape.

We are setting high standards, striving for continuous improvement, and we are never content with the status quo.

We know that superior service is the key to growing volumes and revenues, and delivering on our promise to our shareholders, and we plan for a future that we have every reason to believe is bright for our company and our industry.

Thank you and I will now turn the program over to the operator so that we can begin the Q and A session.

We will now be conducting a question and answer session.

(OPERATOR INSTRUCTIONS) Our first question from the line of Ken Hoexter, with Merrill Lynch.

Please proceed with your question.

Just a quick comment, adding the scripts and the slides on the web, very helpful to have the scripts while you guys talk.

Just, Wick, can you talk a little bit about the coal pricing.

Obviously the peer pricing being up 9%, just such a sizable increase.

Can you talk a bit about were there a large percentage of contracts that came up for renewal on top of your annual price inflators, just such a large and ongoing price increases is great to see, but can you delve into the details there a bi?.

Well, clearly there are a lot of moving parts in that Ken, and thanks for your other comment.

I think I will just let Don comment on all of the factors which played into this quarter.

Good morning, Ken.

It's Don.

As we have indicated in the past, we have got about two-thirds of our business under contract, and the average length of term for those contracts now are three years across all the book of business.

So we have about a third of the two-thirds expiring each year and then the balance of the repricing or product quotes, et cetera.

So, you put all that together and this year we will be repricing about 54% of our total book of business.

In the second quarter, 26% of that 54% was repriced, and as I mentioned in the first quarter, 40% was repriced in the first quarter.

So we didn't really have any unusual volume of activity from a timing perspective in the second quarter.

It will be pretty normalized over the rest of the year with the other two quarters.

So there won't be any big increase or decrease in the third and fourth quarter in terms of the amount of repricing activity.

Now, I also mentioned contract escalations which were stronger in the quarter, and we expect those to continue and then, of course, the effect of higher fuel surcharge revenue also in the revenue and RPU.

Great.

That's wonderful.

Jim, just a quick question on the buy back.

You bought back 218 million, but it looks like 106 million was issued.

I'm guessing that's because of some of the comp that you talked about as things improved.

Will that remain at that level, cancelling out about half of the buy back, or do you think the buy back has a more powerful move as you go forward.

Is there something special about second quarter on the payout terms?

No, the tempo of the share repurchases is going to vary from quarter to quarter.

But, we are certainly committed to the share repurchase program and we have every intent to continue to repurchasing at strong levels, and that reflects our commitment to the program and the significant commitment of capital we have made in the last couple of years.

No, I'm not talking about the repurchase.

I'm talking about what got issued to cancel out a portion of the repurchase.

There was $106 million worth of stock issued on the cash flow.

There were stock issuances in the quarter reflecting option exercises, that's certainly true, and so we did see that partial offset to share repurchases absolutely.

So that's timing of options exercising, not issuing more?

Absolutely option exercises and that alone.

The timing of it is difficult to forecast.

It's going to vary from quarter to quarter, along with the share repurchases.

One technical question the $9 million interest on tax deficiencies, does that mean you are delaying paying your taxes?

These are timing items, and this reflects the completion of the IRS's examination of our tax returns for 2004 and 2005, and it's simply the reversal of interest on tax efficiencies in connection with that.

Okay, last question is, Don, son some of the stuff you mentioned on the Intermodal on the domestic side, are you seeing the LTLs move away or come back onto the rail?

It seems like every time we listen to their calls, they are talking about the desire to get off the rail to keep their network humming, but it sounded like you are saying you are seeing increase in activity.

Is that a more recent phenomenon in that picking up?

Yes, within our eastern local network, we are seeing an increased demand for LTL, we are seeing somewhat of a corresponding decrease in parcel volume and empty trailer repositioning, predominantly for UPS, these were empty revenue moves for trailers.

But we are seeing a stronger domestic truckload demand east of the Mississippi on our network in general.

And we think that somewhere in the range of where diesel fuel is selling now and has been for the past couple of months, there is a tipping point of some kind, which just drives the economics back towards rail for a lot of these folks.

Great.

Appreciate the time.

Thank you very much.

Great quarter.

Thank you.

Our next question is coming from the line of John Larkin, with Stifel Nicolaus.

Good morning gentlemen.

To keep your operating ratios steady year-over-year was really impressive.

I guess I was kind of thinking that the fuel surcharge lag that I understand you have built into many of your contracts would have provided a pretty substantial headwind.

I don't recall you quantifying the headwind.

Could you maybe share with us the impact that that delay had in the second quarter?

John, fuel surcharge recovery in the second quarter was 410 and that was a favorable variance over the second quarter of 2007, which was about equal to the increase in fuel expense in the quarter, so we actually had some favorability as between the two variances there.

I would hasten to add that, in prior quarters, we have seen significant under-recovery of the variance, and also the higher petroleum related costs that are not classified as fuel that rippled through our cost structure.

So, it's a long-term thing.

I think we can't focus on one quarter alone, but have to look at this over a reasonable period of time.

Thank you.

And then it looked as though Triple Crown had a better quarter than one might have guessed given all the trials and tribulations in the auto business.

Is this now the kind of environment where you might consider actually growing that very unique operation beyond even perhaps your own network?

John, we continue to focus on growth in Triple Crown.

It is a good service product with high demand.

We have also been consciously repositioning our market position with Triple Crown away from its dependency on auto parts.

It is still in the range of the high 20s, 20%, 28% or 29% auto parts, but that has been declining as we've reposition equipment into consumer products.

So, we see good demand for that product because, again, it reflects the fuel efficiency of rail, it is a door to door product, and we are seeing good demand outside of the auto industry, and of course we are still committed to that segment too, and we are looking at all opportunities as we go forward.

Longer term, John, you know we have invested a lot in the Triple Crown technology.

We believe in it.

It fits in a very specific market niche that we think we can take advantage of.

We will expand it as it makes sense, but it is a very targeted set of services, and we want to be careful that when we expand, we get it right.

Fair enough.

Just maybe one last question on the regulatory front.

I know the STB is taking a look at the concept of perhaps allowing an ment in the denominator of the ROIC equation that would adjust for replacement cost.

Yeah.

Any sense of how that might be progressing down in Washington?

I have no sense of how it is progressing, although I think their willingness to take a look at it is a very positive signal.

I think it is something that should be looked at.

I think it makes a lot of economic sense, given the nature of our business and the capital investment and the lives of our assets.

So, we and the rest of the industry are very strongly urging the STB to look at that and think about adjusting the way they look at our returns.

Thank you very much.

Our next question is coming from the line of William Greene with Morgan Stanley.

Go ahead with your question.

One quick follow-up on the pricing question.

I assume that there is some mix in your 9% comment, so if you excluded heavier cars, the cars that can haul more and longer distance or the changes in the length of haul, what would the core pricing be?

Bill, we are looking at the core price for the quarter at 9%.

The mix was certainly favorable in coal, with longer export coal, we are getting some higher RPU because of higher tons per car, but across the entire book of business the mix affect was negligible with respect to the quarter.

The 9% is pure yield out of the 19% RPU gain.

Okay, and then if we look at export coal, how are you thinking about the durability of this?

Do you have real good visibility into 2009?

Do you have contracts that go out far enough so you know how the volumes will progress, have you made long-term investments in the business at this point ,or are you just letting it ride?

With respect to our export coal, we have a great pier here in Norfolk, Pier 5, Pier 6.

As I mentioned, we expect 20 million tons over that period this year.

That is half of the capacity of that pier.

We also have additional capacity in terms of rolling stock.

So, we have flex, if the coal supply and the orders are there.

Now, with respect to the orders, we stay in close contact with receivers throughout Europe and Asia, and the input that we are getting is that the export market will continue to be strong through 2010.

Beyond 2010, we don't know, but I think 2009, 2010, we are being told to expect continued demand and we are planning accordingly.

And then just one quick question on the personal injury and environmental claims, was that material in the quarter?

How much was that?

That was a favorable claims development of $12 million and we had offsets for that, though, in the form of derailment related expenses and the two washed, but the casualties and claims component of materials and other was favorable for - -

Thank you.

Thanks, Bill.

Our next question is coming from the line of Ed Wolfe, with Wolfe Research.

Good morning, guys.

Good morning, Ed.

I think what is striking is how quickly pricing seems to have solidified.

It was just a quarter ago when pricing was strong but you were talking about visibility towards 4% of real pricing kinds of increases and now all of the sudden it is 9%, with some visibility throughout the year.

What really changed in the last three months?

Ed, I will let Don comment on it too, but as we go into a year, we are never quite sure, and we don't like to overcommit on what we are going to do.

We've clearly got two solid quarters of pricing under our belts this year and the trends certainly look favorable, so we are now able to give you a clearer picture of the rest of the year.

Don?

It is a good question you are asking obviously.

When we forecasted, we look out over a year, we know what is going to be repriced.

What is hard to read is how the competitive environment continues to change and where the market will actually be with all the market factors, and we felt very comfortable with a minimum of 4%.

And frankly we have seen the value of our service, our service product is very good in the market and our market negotiations are yielding a higher net effect in pricing and we are pleased with that.

So there wasn't any major contract that came up or anything like that.

It was more coming into the year conservative and kind of your best wishes playing out?

We will have to admit to some conservatism there.

Fair enough.

We occasionally are conservative.

Don, on the export coal side you talked about Lamberts and the ability to move 40 million tons versus the 20 million where you are if the orders were there and the supply was there.

Where do you see the bigger constraints, are they on the order side or supply side, and how big of constraints are they?

I think demand for U.S.

coal, metallurgical coal and steam coal, are at a very high level in the global market.

As you might know, Ed, the Drummond Coal Columbia, South American Columbia operation, just went on strike two weeks ago.

That is taking coal out of the European market.

So, coal is tight worldwide, and I think the orders in Europe for met and steam coal will continue to be strong as far out as we can see with the receivers, and that is most of 2009 on into 2010, and perhaps through 2010 as I mentioned earlier.

We have got better coal supply this year on NS than we had last year from central AP, because Consol is back in production at [Buchanan], and we had Trinity and Massey ramp up their two new operations.

I think that we are prepared to handle increased coal for export if the supply and demand match up, the demand is there, and I think probably the unknown equation with less visibility is the supply.

And I say that because the U.S.

Utilities are coming back into the market as well, sometime this year, to start replenishing stockpiles.

Isn't that a guess about supply.

Would you say you could grow 5%, 10%, 20%?

How much can you grow the exports off of this base of 20 million?

I really can't hazard a forecast on that, Ed, because again, it is based on supply.

I think the demand is there.

It will all be predicated on how much supply is made available.

Is any of the CapEx that you are bringing into this year to get the tax benefit related to export coal?

No, not really.

The new locomotives will be going into our unit coal train service, so they will be in the coal arena but not specifically dedicated to the export side.

And last thing on export coal, the 20 million tons at Lambert, what percentage of the total export coal is that?

We expect about 25 million tons to balance the other 5 million will be at a port in Baltimore.

Can you quantify, Jim, what the impacts are of the Midwest floods, and is there any makeup going on with that now?

It really was not significant for us.

We have still yet to quantify that internally, but it really was nothing on the order of what the western roads experienced.

Negligible.

Thanks.

Our next question is coming from the line of Randy Cousins with BMO capital markets.

Couple quick questions, you guys have been making some significant capital investments with some major projects.

I was wondering if you can give us an update of how they are developing up?

Are you getting traffic flow along with plan, and the two that stand out to me are the Meridian Speedway, how much stuff is going over that line, is it on plan?

And then the Rickenbacker, I realize has just opened up, but could you give us a sense of how that one is developing up as well?

Well, a lot of our projects clearly have only been recently announced or underway like Heartland and Patriot.

In terms of the Meridian Speedway, the majority of the work has been done on that corridor to improve capacity and the infrastructure, and the service over that corridor right now is extremely good.

As you know, it is the best route from the West Coast ports to the southeast United States.

There have been some puts and takes from a business standpoint, really driven by what Don talked about earlier in terms of some of the West Coast to East Coast shifts.

But on the other hand, our domestic business in the Dallas Atlanta corridor has grown and has exceeded our expectations and we expect that business to grow.

So, all things considered we are very comfortable with that investment and the way it is going.

And with reference to Rickenbacker, how many cars are pulling into it, or how active is it right now or is it really an ' 09 project?

Oh, no, Rickenbacker is open, we have train service into Rickenbacker.

We are bringing containers in both from the port of Norfolk and from the west.

We built it with capacity but it's an active operation and growing on a monthly basis.

Thank you.

Our next question is coming from the line of John Barnes, BB&T Capital Markets.

Good morning, guys.

In terms of the pricing, you have had the success.

Now, all of the sudden CSX, your competitor, had the small rate case decision go against it by one of their largest shippers, I'm must kind of curious, as aggressive as pricing is common, especially seeing that 9% increase in core pricing on coal, do you feel you are opening yourself up to any of that potential challenge?

Or I guess to expand upon that, do you currently have anything, either major or minor, from a rate case standpoint pending against Norfolk Southern by one of your customers?

We don't have any rate cases at this time.

We are going to proceed along the path of charging for the value of our service, and we think that that's a high value.

We think that we offer a superior alternative in the marketplace, and we will be trying to realize the value of that when we discuss rates with our customers.

We also work very hard on customer relationships.

We think we have strong relationships with most of the people that we do business with, and we anticipate continuing that as well.

So we will just have to see how this plays out but we don't have any rate cases at this time.

Okay.

This is Don.

Just a quick correction.

You mentioned the 9% relative to coal.

The 9% was the yield across the entire book of business.

My apologies.

Sorry about that.

Thank you.

In terms of the operating ratio, it's only 10 basis points worse than it was a year ago, and yet fuel prices were up pretty substantially.

Do you think at this juncture you have pulled out a lot of the costs, and going forward, it is going to be a little bit tougher or - - you guys are on the cusp of realizing true operating ratio improvement even with this much, much higher fuel cost.

I guess I'm just trying to extrapolate that out, what does it mean eventually when volumes are a little bit better and maybe fuel begins to moderate or at least stabilize?

Have you re-visited your ultimate operating ratio target, maybe two or three years down the road, given how successful you have been in the face of this massive increase in fuel costs?

The fact that we have been able to hold our operating ratio where it is, of course, is a real tribute to Steve Tobias and his team in terms of the efficiency of the operation that they are running.

We never, ever lose site of operating ratio, and we talk about it a lot.

In terms of where we are trying to go with it, we clearly have targets to try to take it down over a period of a few years.

We will be talking more about what some of those targets are when we start telling you more about our project Track 2012.

But it is not a question of re-evaluating.

It is an indicator that we never lose site of and we think that there is still things to be done.

We know that we can still run our company more efficiently and we are committed to doing that.

Okay.

Nice quarter, guys.

Thanks for your time.

Our next is from Jason Seidl, with [Damen Rose].

Thank you, and good morning all.

When I'm looking ahead here, obviously we are starting to see a little bit of a pickup in car loadings from you guys, which is probably very much welcome on the railroads, since it seems that's all you really are missing.

But your average employee count is still down a little bit.

Should we expect this to ramp up in the back half of the year and into '09?

No, as we talked before, in our employee counts, we try to manage through that in a very thoughtful way when we were ramping up our employee counts to improve service and to handle the additional volume growth, we get questions like that, and we always said when we need to do something about employee counts, our demographics and attrition rates are such that we can take employee counts down over a reasonable period of time just through a cessation or reduction in hiring and that's, in fact, what we are doing right now.

We are comfortable with the number of employees we have right now on the railroad.

We are comfortable that we can handle more business with our employee count in this range, and you may see it go down a little bit more year-over-year as 2008 progresses, but I expect our employee count to remain roughly in the range it is now, even if volume picks up for some substantial period of time.

Okay.

Thank you.

Follow-up question, you mentioned that you are expecting some utility coal to pick up as the stockpiles are rebuilt.

Any sense of in terms of how many days' supply the utilities have right now out east?

We have been hearing that some of the utilities in the south Atlantic are fairly low.

This is Don.

The input we get, our northern utilities the stockpiles are below target, and we are receiving information that the southern utilities have recently moved below target.

So in the quarter, in the second quarter, our tons in the north were up 3% ,and our tons in the south were down 5%.

So we expect that trend to reverse in the southern utilities, as they work on replenishing stockpiles, and we expect the positive trend in the north to continue because we have got some new business moving to the Shelocta plant that I mentioned, as well as replenishment of stockpiles.

Gentlemen, thank you for the time as always.

Our next question is coming from the line of Tom Wadewitz, JP Morgan.

Yes, good morning.

Good morning, Tom.

Let's see, I have two different topics I wanted to touch on.

First on the coal yield growth, which accelerated pretty sharply.

My assumption is that is primarily driven by the timing of new export coal contracts being signed on April 1st.

Correct me if I'm wrong on that, but are those contracts still one year agreements, or have you signed up longer agreements than historical?

Tom, with respect to coal overall, we had repricing of contracts in the quarter, including our export, but also the impact of some repricing and utility as well.

Secondly, a much stronger escalation in existing contracts, and then fuel in addition to that, and then of course the overall length of haul differential on export, versus the utility.

As I mentioned, export we are averaging about 440 miles per load, and on utility which is the much larger book of business for our coal franchise, we average about 280 miles.

So all of that, on end, resulted in a 38% increase in RPU.

With respect to your question on export, we negotiate our export arrangements each year.

Okay, so it sounds like - - was export a meaningful factor in that?

Obviously, it was one of several, but was that a meaningful contributor to the acceleration, or not really?

Well, it is certainly a meaningful contributor along with those other factors that I've mentioned.

Okay and it is one year, so if coal demand is strong again next year you might see a further boost again next April?

Well, we always follow the market and we are looking at the transportation market in the marketplace, so we will just have to wait and see.

Okay.

But you get another shot at it given that you stuck with the one year approach.

Transitioning to Intermodal, it has been a while since you have seen growth on the Intermodal side, obviously International has been a strong headwind.

Do you think you are on the cusp of seeing a pretty good transition to some stronger volume growth there, and also you commented on the benefit from fuel, but what about tighter truckload capacity?

It does seem like you've see some capacity rationalization in truck load.

Well, Wick mentioned the higher fuel costs for trucking and the impact that that is having in terms of conversion to rail.

You might have noted, Tom, in JB Hunt's second quarter announcement that they advised that they were increasing Intermodal capacity by 10%, and we are seeing JB hunt within the east continue to take a very aggressive posture, converting truck traffic, highway traffic, over to rail Intermodal.

We are seeing others, like U.S.

Express and others do the same thing.

So, we are seeing within the eastern local network on NS, double digit growth.

Also the Rickenbacker logistics center, which I mentioned in the prepared comments, and we had a question on, we are seeing better than expected activity at that new terminal, to the extent that the local airport authority there is accelerating some highway work to improve the ingress and egress at that facility, and that work is being done in advance of the schedule because of growth there.

Do you think it is likely though that you see in the total Intermodal volumes you see a transition to some meaningful growth there, with International maybe as less of a headwind.

As we lapped the international numbers, and with the more robust environment we see in the domestic, I think it is certainly a plausibility scenario that we are going to see year-over-year volume growth into the second half.

Last one.

How much do you think truck capacity matters?

You can choose Intermodal because of price, or you can choose it as a capacity play?

Do you think there is much sensitivity in terms of if truckload capacity gets tighter you could see further flow to you on the Intermodal side?

That is a good point, Tom, that you are making.

I think that, truckload capacity, we know that tractor sales are not up, they are down.

Truckload capacity with respect to repositioning empties for loads in this market is very constrained because of high diesel fuel prices.

So I think the table is set quite well for Intermodal growth in the U.S., and in particular our network because we have planned for it.

Great congratulations for the terrific results.

(OPERATOR INSTRUCTIONS) Our next question is coming from Gary Chase with Lehman Brothers.

Don, wondered if you can clarify something for us.

You mentioned escalation, better than expected escalation as a factor of what drove that 9% outcome, was there just RCAF, or is there another story there?

You emphasized it when you were answering a question specific to coal pricing, was that a material factor outside of the coal segment?

Certainly on contract escalation the RCAF is involved.

But we have also converted a lot of our contracts to fixed contract escalator, fixed percentages, and the blend of our RCAF, plus the fixed percentage escalators, are stronger going forward and we saw the result of that in the second quarter.

I guess I'm still trying to get my arms around some of the comments you were making earlier when you were talking about the 9% and the fact that you had to admit to a little bit of conservatism.

I'm trying to get my arms around if the market moved this last quarter, so some of that might have been conservatism, but some of it might also be the pricing environment actually is accelerating.

Is there any way to think about how much of that 9% versus the 4 was was actual market movement instead of you being conservative.

Well, first of all, the 4% at the beginning of the year, we mentioned it was a minimum of 4, which gave us certainly latitude to go above 4.

But, we have seen a better market for transportation for our rail service, than we had projected late, in the second half of last year when we put our forecast together.

The 7% in the first quarter, the 9% in the quarter, so that is a range.

We are comfortable with that range going forward for the balance of the year.

Certainly, we see transportation demand in certain sectors continuing to be robust, Coal being one of them, Agriculture being another.

The Metals market is still strong and domestic Intermodal is still strong.

So, there is a an escalation component and a market component.

That's correct.

This one for Wick.

UPS mentioned this yesterday, you noted in your prepared remarks the thought that people would be re-thinking supply chains here, given fuel prices and the fact that transportation costs have increased pretty substantially as a result of that.

As you look out over the next several years, there are some positives that you mentioned in truck conversion.

Are there some potential offsets to that?

Do you think it will change your CapEx outlook, either in terms of the dollars you will need to spend up or down, and will it shift some of the priorities that you have?

You know, that's a great question, our crystal ball is always as cloudy as anyone else's.

I have to say that I think right now the projects we are working on and the way we are addressing the marketplace is something we are all comfortable with in terms of where we think the markets are headed.

The shift to domestic Intermodal, which we keep talking about, I think is going to be one of the primary outcomes of this re-evaluation of supply chains, and I think our franchise with what we are doing with it to strengthen it right now will be particularly well situated to take advantage of that.

So, we expect to continue to invest in the network, to strengthen the franchise.

I think we are nimble enough so if we start to see another trend to emerge we can continue to adjust, but right now the course we are on is something we are very comfortable with.

Thanks, guys.

We have time for one final question and that question will be coming from the line of Matt Troy with Citigroup.

Following up on the Intermodal discussion, I was wondering what you are hearing from the shipping lines, the international shipping lines, with respect to peak season?

They generally tend to be creatures of habit, but we are seeing some change some behaviors with slow steaming and changing frequencies.

I was wondering if you could just talk about what you are hearing in the near term about the peak season taking shape, and also, how sticky some of the business that might be getting diverted from the West Coast ports might be?

With respect to the first part of your question, Matt, on an Intermodal or international peak in the fall, we will probably see some up-tick in demand.

I don't think we will see anything that looks like a traditional peak that we saw several years ago.

Inventory supply chain management has changed since then, and I think we saw more of a steady state flow of goods through the summer into the fall now for the retail season.

So, that seems to have fundamentally changed, so we don't expect a big fall peak in Intermodal.

We do expect a good grain crop even with the flooding.

The latest U.S.D.A.

projections are fairly positive with respect to the corn and soybean crop.

We will see the normal increase in demand in that sector.

With respect to the all-water service, repeat your question because I want to make sure I got your question correct.

To the extent, I'm focusing on box trade, container counts, handled by Norfolk and the East Coast railroads, and basically what I'm trying to get a sense of is, if the shipping lines may be diverting international traffic from the West Coast ports to the East Coast ports, one, is it possible to quantify what that diversion is, what it means to you folks, and two, how sticky might some of that business be if people on the international front are evaluating import and export destinations?

We do quantify that, and as we have seen our business shift where 54% of our containerized freight is coming through East Coast ports, obviously we watch that very, very keenly.

Five years ago it was only 20%, so it has grown that much.

We are also looking at how we serve those ports, and of course Heartland Corridor and the Port of Norfolk is a great example of that.

Rickenbacker Valley, in terms of a logistics center terminus, is another great example of that.

So, we have been planning for this shift because, frankly the Asian steamship lines for several years, for the last five to six to seven year,s have been telling us we should plan to see this shift taking place, and we are seeing it take place.

Now, with respect to the traffic, we see Port of Savannah has benefited significantly from that trend.

The Port of Hampton Roads, Norfolk certainly has benefited, and we've certainly seen New York pick up additional traffic as well.

We are running large, very efficient train service from Savannah to Atlanta, for example, and we're beginning to see some demand go west of Atlanta from Savannah.

At some point in the future, I would not be surprised to see East coast port business coming through Savannah, for example, going back as far as Memphis.

We will probably see Norfolk traffic going back as far back as Chicago.

Is there any way to quantify in the last six months, has there been an acceleration of the diversion from other ports, be it West Coast or otherwise, to your system, or is it too difficult to disaggregate in terms of the longer-term trend?

Our numbers indicate that from the first quarter to the second quarter we actually saw an acceleration of all water conversion to the East Coast ports.

Can you put a number to that?

I would rather, for the shipping lines, to talk about that, because as we have pointed out in the past, we are very much working to promote traffic from both coasts, and we are positioning our ramps and our logistics centers where we can handle the traffic either through our East Coast ports or West Coast ports.

And it is up to the shipping line to make the decision, along with their customers, as to which port of entry they use in that supply chain.

We are neutral with respect to that.

We just want to be in position to serve either coast.

Got it.

Thank you very much.

Thank you.

Mr.

Moorman, there are no further questions at this time.

Thank you very much, everyone.

We look forward to talking to you at the end of the third quarter