Norfolk Southern Corporation (NSC) Q2 2008 Earnings Report, Transcript and Summary

Greetings and welcome to the Norfolk Southern Corporation Second Quarter Earnings Conference Call. At time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal 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 man begin.

Thank you and good morning. Before we begin today's call, I would like to mention a few items. First I 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, transcription 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 assist... 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 accurate [ph] judgment as to what may occur in future. Statements that are forward-looking can be identified by using the word 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, some of which maybe above of our control. Please refer to our annual and quarterly results filed with the SEC for discussions of those risks and uncertainty; we see those most important. Now, it is my pleasure to introduce our Chairman, President and CEO, Wick Moorman

Thank you, Leanne, and good morning everyone. It's 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 in to the second quarter. And I am 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 was the highest in our history, up 15% over the 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 catalysts driving these records results continue 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 of 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 level 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's part of our compensation calculations. Since its introduction at the first of the year, this measurement have sharpened our operational focus by measuring how well we adhere to our celebrate operating plans. 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 standards. And notwithstanding the near impact... near term impact that the Midwest flooding on our performance, I am happy to say that we are seeing both year-over-year and sequential improvement in the measurement. As a result, we clearly continue to benefit from value based pricing commensurate with our strong service level. And demand for our business is increasing as we strategically expand our portfolio of service offerings in response to a changing market place. 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 from capital spending this year for new locomotives and rail replacement work. The rail replacement will give us a tax advantage to head start on next year's program, and the additional power also tax advantage, which we expect to take delivery up 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'll recall, we've 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'll now turn the program over to Don Seale, who will walk you through our second quarter results from the 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.

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 am 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 3, the second quarter represented our 23rd consecutive quarter of revenue per unit growth. With the exception of Automotive, six of our seven business segments produced 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 re-pricing activity and results for Coal and Intermodal than we saw last year, along with continuing re-pricing 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 4 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 gains. In addition, we have broadened our fuel surcharge coverage, which currently stands at 94% of total revenue, 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 on slide 5. 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. Now, turning to slide 6, and the second quarter, it's also notable how our diverse portfolio of business and project driven growth worked to offset some of the weakness in housing related commodities and the automotive sector. Agricultural volumes set another quarterly record, while increased metals 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 business increased by some 5,400 loads during this period. As shown in slide 7, we also continue to see the effects 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 exports such as coal, grain, 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 our total import volume, which was offset by a 14% gain in export traffic. Now, turning to the highlights of our individual markets; during the quarter, as shown on slide 8, Coal revenue of $775 million was up 34% over second quarter 2007, 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 segments, as shown on slide 9, 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 robust pace. Slide 10 shows our Lamberts 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 carloads 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. Volume to southern utilities declined by 5%, while volume to 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 at 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 to higher coal prices and competition from export coal demand within this segment. Now turning slide 12 in our Intermodal market; record revenue in Intermodal for 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 in traffic mix. Positive mix was driven by the 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 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 from 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 from the U.S. are facing problems due to a lack of equipment at inland locations and a lack of vessel capacity. And as in the first quarter, we continued to see declines in the revenue movement of empty containers back to port locations. During the quarter, empty revenue movements 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 2007 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 and shipments were driven by continued growth in ethanol, which was up 20%, primarily to the Southeast market. Export corn and feed shipments coupled with new business also contributed to these gains. Metals & 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. Lower demand for construction and paving materials also contributed to the decline. Finally, the weak housing market continues to impact our Paper and Forest products sector. A 25% decline in lumber and construction related materials was partially offset by a 12% gain in export pulpboard. 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 effects 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 offsetting these 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 its most recent expansion. But as we know, further plant and production rationalization in the auto industry has been announced. Slide 17 depicts announced closures and shift reductions for the Big 3 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 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 on July 15 Volkswagen announced plans to construct a new auto assembly plant along our mainline 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 from the housing and automotive 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 App. Higher production this year is being driven by the resumption of mining at Consol's Buchanan facility, 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 2008. 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, greater terminal capacity such as our new Rickenbacker Logistics Center in Columbus and our solid service all help 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'll turn the program over to Jim for our financial report. Jim?

Thank you Don. I'll now provide a review of our overall financial results for the second quarter. Slide 2 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 3 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 percent 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 6 lists the reasons for the increase. Incentive compensation, which covers nonunion employees as well as locomotive engineers and dispatchers, rose by $19 million due to a higher projected payout. Secondly, stock based compensation added $13 million primarily due to a stock priced increase of over $8 during the quarter. Payroll 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 purchased 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 offset 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've 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 a 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% percent, 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 cents, 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 purchases since inception to 54.4 million shares at a cost of $2.7 billion. Thank you for your attention. And now, I'll turn the program back to Wick.

Thank you, Jim. Well, as you've heard, this was an exceptional quarter for our company even in the base of some economics headwinds. Turning to the balance of the year, as we've said before, the economy continues to be clearly softer than we had originally anticipated. However, we do expect that our balanced business portfolio and superior service offerings will continue to help offset the clients in our business is 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 prior gains to-date in July. As you heard, we are seeing continuing strength in coal particularly on the export side ag and metals with softness in construction, paper and porous products chemicals and automotives. While Intermodal volumes are down slightly year-over-year, the import volume seem to have stabilized, exports are growing, and the domestic side has really begun to accelerate as higher and higher diesel prices as may truck to rail conversion more and more compelling. Also as we discussed before, the project driven growth in our Intermodal and general merchandise markets is progressing as planned, which should bolster volumes over the remainder of the year. Something that interested to have [ph] stated before, we remain optimistic about the future. The macro trend that has benefited us are clearly continuing first systemically high fuel prices, which are now to the point that companies are beginning the reevaluate their supply chains manufacturing basis with an increasing emphasis on rail transportation. Second as Don outlined, the continued shift of import and export traffic from the West Coast ports to the East Coast ports, and finally an ever increasing emphasis on environmental and sustainability issues. We believe that Norfolk Southern's particularly well situated to take advantage of these plans. We are working hard to strengthen our franchise initiatives like the Heartland, Patriot and Crescent Corridors as well as their 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 on a lot of different areas to keep our business moving on the fast track, as we strategically navigate a rapidly changing landscape. We're setting high standards, striving for continuous improvement and we are never content with the status quote. We know the superior service is the key to growing volumes in revenues and delivering on our promise to our shareholders, we plan for a future that we have every reason to believe the strides for our company and our industry. Thank you and I'll now turn the program over to the operator, so that we can begin the Q&A session. Question And Answer

Thank you, sir. We'll now be conducting a question-and-answer session. [Operator Instructions]. Our first question is coming from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.

Great, good morning. Just a quick comment; I think adding the scripts and the slides on the web... very helpful to have this scripts while you guys talk. Just... well, can you talk a bit about the coal pricing? Obviously it was the peer pricing being up 9%, such as sizeable increase. Can you talk a bit about whether a large percentage of contracts that came up for a newer on top of your annual price inflators to such a large... and ongoing price increases. It's great to see, but can you delve into the details there a bit.

Well, clearly there are a lot of moving parts in that can, and thanks for your other comment. I think I'll just let Don comment on all of the factors, which played into this quarter.

Good morning Ken, this is Don. As we've indicated in the past, we've 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 re-pricing or product quotes et cetera. So, you put all that together and this year we'll be re-pricing about 53%, 54% of our total book of business. In the second quarter, 26% of that 54% was re-priced; and as I mentioned in the first quarter 40% was re-priced in the fourth 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 quarters. So it won't be... there won't be any big increase or decrease in the third or fourth quarter in terms of the amount of re-pricing activity. Now also, I've mentioned contract escalations, which were stronger in the quarter and we expect those to continue and then course the effect of higher fuel surcharge revenue also in the revenue and RPU.

Great, it's wonderful. Jim, just a quick question on the buyback. You bought back 218 million, but it looks like 106 million was issued... I'm taking... I'm guessing that's because of some of the comp that you talked about as things improved. Will that remain at that level, canceling at out about half of the buyback? Could you think the buyback has a more powerful move as you go forward like you said something special about second quarter on the payout terms.

That'll be... the type of the share repurchase, it's going to vary form quarter-to-quarter. But we are certainly committed to the share re-purchase program, and we have every intent to continue repurchasing at strong levels and that reflects our commitment to the program and the commitment, significant commitment of capital we've made in the couple of years.

No, no, I am not talking about the repurchase. I am talking about what got issued to cancel out a portion of the repurchase. So there was $106 million worth of stock issued on the cash flow.

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

So that timing of option is exercising, not issuing more.

Absolutely, absolutely auction exercises and that alone. It... and the timing of it is difficult to forecast. It's going to vary from quarter-to-quarter along with the share repurchases, yes.

And one technical question, the $9 million interest on taxed efficiencies, does that mean your delaying in paying your taxes?

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

Okay. And last question is on the... Don, on some of the stuff you mentioned on the Intermodal on the domestic side, I just want to understand are you seeing the LTLs move away or comeback on to rail? It seems like every time we listen their calls, they are talking about the desire to get off the rail to keep their networks coming. But it sounded like you were saying you are seeing an increase in activities. Is that something a more recent phenomenon and then that picking up?

Yes, within our eastern local network, we're seeing an increased demand for LTL, which seeing somewhat of a corresponding decrease in parcel volume, an empty trailer repositioning from... 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 diesel fuel is selling now and has been for the past couple of months, there a tipping point of some kind, which describes the economic vectors real 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 from Stifel Nicolaus. Please proceed with your question.

Hey good morning gentleman.

Good morning, John.

To keep your operative ratios steady year-over-year was really impressive. And I guess I was kind of thinking that the fuel surcharge lag that I understand 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 of that delay had in the second quarter?

John, fuel surcharge recovery in the second quarter was 4.10 [ph] and that was a favorable variance over the second quarter of 2007, which is somewhat outlaid, but it was about equal to the increase in fuel expense in the quarter. So we actually had some favorability as between the two variances there. But I would hasten to add that in prior quarters, we've seen significant under recovery of the variance and also that higher petroleum related costs that are classified as fuel have rippled through our cost structure. So it's a long-term thing. I think we can focus on one quarter alone, but have to look at this over reasonable period of time.

Okay, thank you. And it looked as though Triple Crown had a better quarter than one might have guessed given and all the trials and tribulations in the auto business. Is this now the kind 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's 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's still in the range of the high 20s, 20%, 28%, 29% auto parts, but that's been declining as we repositioned equipment into consumer products. So, we see good demand for that product, because again it reflects the fuel efficiency of rail, it's a door-to-door product. And we are seeing good demand to 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.

Yes, longer term, John, we have invested a lot in the Triple Crown technology, we believed in it. It fits in a very specific market niche that we think we can take advantage of. We'll expand it as it makes sense, but it is a very targeted set of services, and we want to be careful when we expand, we get it right.

Fair enough. Just maybe one last question on the regulatory front, the STB is taking a look at the concept of perhaps allowing an adjustment in the denominator of the ROIC equation that would adjust for replacement costs.

Yes.

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

I have no sense of how it's progressing although I think their willingness to take a look at it is a very positive signal. I think it's 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 in the lives of our asset. 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 Green with Morgan Stanley. Please go ahead with your question, sir.

Yes, just one quick follow up on the pricing question; I assume that there is some mix in your 9% comment. So if you excluded sort of heavier cars, the cars that haul more and longer distance for the changes in the links of haul. What would sort of core pricing be?

Bill, we're looking at the core price for the quarter at 9%. The mix was certainly pregnable in coal with longer export coal. We're getting some higher RPU because of higher tons per car. But across the entire book of business, the mix effect was negligible with respect to the quarter.

Okay.

So 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 to go up fair enough that you know sort of how the volumes will progress? Have you made long-term investments in the business at this point or you just kind of letting it ride?

with respect to our export of coal, we have a length peer here in Norfolk, peer five, peer six. As I mentioned, we expect 20 million tons over that peer this year. That's half of the capacity of that peer. We also have additional capacity in terms of rolling stock. So, we have flex if the coal supply in the orders of 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 and 2010, we're being told to expect continued demand.

Okay.

And we are planning accordingly.

Okay, 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 developments of over $12 million, and we had offsets for that though in the form of derailment related expenses in the tube washed [ph].

Okay.

But calculate some claims component of materials and other was favorable for.

Thank you.

Thanks, Bill.

Our next question is coming from the line of Ed Will, Worth Research [ph]. Please go ahead with your question, sir.

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, where you were talking about visibility towards 4% of real pricing kinds of increases. And now all of a sudden it's 9% with some visibility through the end of the year. What's really changed in the last three months?

Well, Ed, I'll let Don comment on it, too. But as we go into a year, we're never quite sure, and we don't like to over commit on what we are going to do. We clearly got two solid quarters of pricing under our belts, this year. And the trend certainly looks favorable. So we're now able I think to give you a clear picture of the rest of the year. Don?

It's a good question you are asking obviously. And when we forecasted, we look out over a year, we know what's going to be re-priced. What's 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 thought we are very comfortable with a minimum of 4%, and frankly we've 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're 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'll have to admit to some conservatism there.

Fair enough.

We are conservative.

Talking of that [ph]... on the export coal side, you talked about Lamberts and the ability to move 40 million tons versus the 20 million where you are, a few orders were there and the supply was there. Where do you the see the bigger constraints. Are they on the order side or the supply side and how bigger 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, at the Drummond Coal Columbia, South American... Columbia operation is on strike, 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 meth 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 perhaps through 2010 as I mentioned earlier. We've got better coal supply this year on NS than we had last from Central App, because Consol is back in production at the Buchanan, and we had Trinity and Massie ramp up their tuning operations. I think that we're... we are prepared to handle increased coal for export if the supply and demand match up, the demand is there, and I think the probably the unknown equation with less visibility is the supply. And I say that because the U.S. utilities are coming back in to the market as well some time this year to start replenishing stock volumes.

Now to guess about supply, would you say you could grow 5%, 10%, 20%? How much can you grow the exports after this base of $20 million?

I really can't answer to a forecast on that, Ed; because again it's 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 brining into this year to get the tax benefit related to export coal.

No, not really. It... 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 Lamberts, what percentage of total export coal is that?.

We expect about 25 million tons to balance with the other 5 million will be at Port of Baltimore.

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

It really was not significant for us. We have sort to quantified that, but... internally, but it really was nothing on the order what the western roads experience; negligible.

Okay, thanks.

Right.

Our next question is coming from Randy Cousins with BMO Capital Markets. Please go ahead with your question, sir.

Good Morning. Couple of quick questions; you guys have been making some significant capital investments with some major projects, and I was just wondering if you can give us an update on sort of how they are developing up, are you getting traffic flow along with plan and to the standout to meet or sort of the Meridian Speedway; how much tough is going over that line? Are you... 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 are underway like Heartland and Patriot. In terms the Meridian Speedway, the majority of work has been done on that quarter to improve capacity and the infrastructure. And the service over that quarter right now is extremely good. As you know, it's the best rap from the West Coast ports to the South East 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 ships. But on the other hand, our domestic business in the Dallas Atlanta quarter 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's going.

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

No, Rickenbaker is open. We have train service in the Rickenbaker. We are bringing containers in both from the Port of Norfolk and from the west. We build it with capacity, but it's an active operation and growing on a monthly basis.

Okay, thank you.

Our next question is coming from the line of John Barnes with BB&T Capital Markets. Please go ahead for your questions. John Barnes - BB&T Capital Markets: Hi, good morning guys.

Good morning. John Barnes - BB&T Capital Markets: In terms of the pricing, you've had the success in all the sudden CSX, your competitor had the small rate case decision go against about one of one of their large shippers. I am just kind of curious as aggressive as pricing as common especially seeing that 9% increase in core pricing on coal, are you opening... do you feel like yourself up to any of that potential challenge or and I guess to expand from that or you do you currently have anything either major or minor from a rate case standpoint, pending against Norfolk Southern by one of your customers?

Well, 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'll just have to see how this plays out, but we don't have any rate cases at this time. John Barnes - BB&T Capital Markets: 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. John Barnes - BB&T Capital Markets: My apologies, sorry about that; thank you. And then in terms of the operating ratio, it's only 10 basis points worse than it was a year ago and yet the fuel prices were up pretty substantially. Do you think at this juncture you pulled out a lot of the cost and going forward it's going to be a little bit tougher or I mean, you guys were on a cusp of realizing true operating ratio improvement even with this much, much higher fuel costs. And 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, do you guys... have you revisited your ultimate operating ratio target maybe two or three years down the road given how successful you've been in the face of this massive increase in fuel costs?

Well, the fact that we've been able to hold operating ratio where it is of course it's a real tribute to Steve Tobias and his team in terms of the efficiency of the operation that they're running. We never ever loose sight of operating ratio. And we talk about it a lot in terms of where we're trying to go with it, we clearly have targets to try to take it down over a period of the few years. We'll be talking more about what some of those targets are in... when we start telling you more about our project track 2012. But we... it's not a question of reevaluating, it's an indicator that we never lose sight 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 John Barnes - BB&T Capital Markets: Okay, nice quarter guys. Thanks for your time.

Our next question will be coming from the line of Jason Seidl with Dahlman Rose & Co. Please go ahead with your question. Jason Seidl - Dahlman Rose & Co: Thank you good morning all. When I am looking ahead here, obviously we are starting to see a little bit of a pick up in carloads from you guys, which is probably very much welcome on the rail roads. It just seems like that's all you are really missing. But your average employee counts still down a little bit. Should we expect this to ramp up in the back half of the year in into '09.

No, as we've talked before about 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 say that 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 a reduction in hiring, and that's in fact what we're doing right now. We are comfortable with the number of employees we have right now on the railroad. We're 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 that it is now even if volume picks up for some substantial period of time. Jason Seidl - Dahlman Rose & Co: Okay, thank you. And then a follow-up question, you mentioned that you are expecting some of the utility coal to pick up as the stockpiles are rebuilt. Any sense of... in terms of how many days supply utility side, right now. We have been hearing a lot of some of the utilities in the South Atlantic are fairly low.

This is Don. The input that we get are 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 funds in the north were up three percent and our tons in the south were down five percent. So we expect that trend to reverse in the southern utilities as they work on replacing stockpiles. And we expect the positive trend in the north to continue, because we've got some new businesses moving to the Shelocta plant that I mentioned as well as replenishment of the stock piles. Jason Seidl - Dahlman Rose & Co: Okay. Gentlemen, thank you for the time as always.

Thank you. Our next question is coming from the line of Tom Wadewitz with JPMorgan. Please proceed with your question.

Yes, good morning.

Good morning, Tom.

Let's see, I've got I guess two different topics, I wanted to touch on. First on the coal yield growth, which accelerated pretty sharply. My assumption is that that's primarily driven by the timing of new export contracts, 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 in historical?

Tom, with respect to coal overall, we had re-pricing of contracts in the quarter including our export, but also the impact of some re-pricing in utility as well. Secondly, a much stronger escalation in existing contracts; and then the 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 all in the end resulted in 30% increase in RPU. With respect to your question on export, we negotiate our export arrangements each year.

Okay, so it sounds like, I mean was export a meaningful factor in that, obliviously it was one of several, but was that a meaningful contributor to the acceleration or not really.

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

Okay, and it's 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 marketplace. So, we'd just have to wait to see.

Okay. But you get another shot at it given that you stuck with the one year approach. Let's see on the transition of Intermodal, it's been a while since you've seen growth on the Intermodal side. Obviously, international has been a pretty strong headwind. Do you think that you are on the cusp of seeing some... a pretty good transition in some stronger volume growth there? And I guess also you commented on the benefit from fuel, but what about tighter truckload capacity, because it does seem like, you seem some capacity rationalization in truckload.

Wick mentioned the higher fuel costs for trucking and the impact that that's actually adding in terms of conversion to rail. You might have noted Tom [ph] and J. B. Hunt's second quarter announcement that they admire that they were increasing Intermodal capacity by 10%, and we're seeing J. B. Hunt in the... within the East continue to take a very aggressive posture, converting truck traffic, highway traffic over to rail Intermodal. We're seeing others like US Express and others do the same thing. So, we're seeing within the Eastern local network on NS double digit growth. Also the Rick and Blocker Logistics Center, [ph] which was... 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.

So do you think it's likely though that you kind of... that you see in the total Intermodal volumes you see a transition to see meaningful growth there with international, maybe as less of the headwind.

We... as we lap the international numbers and with the more robust environment, we see on the domestic, I think it's certainly applausable scenario that we're going to see year-over-year volume growth into the second-half.

Okay. And how... last one, I'll I guess pass along. Will you held the last [ph]... how much do you think truck capacity matters? I mean you can choose Intermodal because of price or you can choose as the capacity play. Do you think there is much sensitivity in terms of this truckload capacity really gets tighter that you could see further flow to you on the Intermodal side?

I think that is it's a good point, Tom that you're making. And I think that truckload capacity we know the tractor sales are not up, they are down. Truckload capacity with respect to re-positioning AMTs for loans 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 plan for it.

Okay great. Well, congratulations on the strong results.

Thank you.

Thanks, Tom.

Thank you. [Operator Instructions]. Our next question is coming from the line of Gary Chase [ph] with Lehman Brothers. Please proceed with your question.

Good morning, Don. Don, wondered if you could just clarify something for us. You mentioned escalation better than expected escalation as a factor in what drove that 9% outcome. Was that just RCAP or is there another story there. And you emphasized it when you were answering our questions specific to coal pricing. Was that a material factor outside of the coal segment?

Certainly on contract escalation, the RCAP is involved. The RCAP was robust in the second quarter, but we've also converted a lot of our contracts to fixed contract escalators fixed percentages. And the blend of RACP plus the fixed percentage escalators are stronger going forward, and we saw on the result of that in the second quarter.

Want to get some... I am still trying to get my arms around some of the comments that you were making earlier when you were talking about the 9% and the fact that you'd had to admit to a little bit of conservatism. And I am trying to get my arms around whether the market has also moved in the last quarter, so some of that might have been conservatism, but some of it might also be the pricing environment actually is accelerating. So anyway to think about how much of the 9% versus the 4% was actual market movement instead of you being conservative?

First of all, the 4% at the beginning of the year, we mentioned it was a minimum of four. When you gave us... we certainly latitude to go above 4%. But we have seen a better market for transportation for our real 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 second quarter, so that's 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 very robust, coal being one of them, agriculture being another, the metals market is still strong and domestic Intermodal is still strong.

So there is an escalation component and the market component.

That's correct.

Okay. And then just one for Wick. UPS mentioned this yesterday, you noted in your prepared remarks the thought that people would be rethinking supply chains here given fuel prices and the fact that transportation cost 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 think it will change your CapEx outlook either in terms of the dollars you'll need to spend up or down and will it shift some of the priorities that you have?

It's a great question. Our crystal ball is always as cloudy as anyone else's, but I have to say that I think right now the projects that we are working on, and the way we are addressing the marketplace is something that we are all very 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 chain, and I think our franchise with what we are doing with it to strengthen it right now. We'll 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 that if we start to see another trend emerge, we can adjust. But right now. I think the course we are on is one that we are very comfortable with.

Okay, thanks guys.

Thank you. We have time for one final question. And that question will be coming from Matt Joy [ph] of Citigroup. Please go ahead with the questions.

Yes, thanks. Just following up on the Intermodal discussion; I was wondering what you are hearing from the shipping lines, international shipping lines with respect to peak season? It generally tend to be creatures of habit, but you're seeing them change some behavior was slow steaming changing frequencies. I was wondering if you could just talk about what you're hearing in the near term about the peak season taking shape, and two how sticky some of the business that might be getting diverted from the West Coast ports might be?

With respect to the first question, first part of your question, Matt, on an Intermodal or international peak in the fall, we will probably see some uptick in demand. I don't think, we will see anything that looks like a traditional peak that we saw several years ago. Inventory management... supply chain management has changed since then, and I think we see more of a steady state follow-up goods through this summer into the fall now for the retail seasons. So that seems to have fundamentally changed, so we don't expect a big fall of peak in Intermodal. We do expect a good rain crop, even with the flooding, the latest USDA projections are fairly positive with respect to the corn and soybean crop. So, we will see the normal increase in demand in that sector. Now with respect to the all water service, repeat your question, because I want to make sure that I've got your question correct.

To the extend that the... I am focusing on box trade, container counts, the Hemambi, [ph] CSX... excuse me, Norfolk in the East Coast rail roads. Basic, what I am trying to get a sense of is the shipping lines maybe diverting international traffic from the West Coast ports to the East Coast ports. One: is it possible the 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've seen our business shift, we're 54% of our container, I'm afraid [ph] coming through East Coast ports. Obviously, we watch that very keenly. Five years ago, it was only 20%, so it's grown that much. We are also looking at how we serve those ports, because Heartland Corridor, Port at Norfolk is a great example of that. Rickenbacker in the Ohio valley in terms of the logistic center terminus is another great example of that. So we're... we have been planning for this shift, because frankly the Asian steam ship lines for several years. For the last five to six to seven years had been telling us that we should plan to see this shift taking place and we are seeing it take place. Now with respect to the traffic, we see Savannah... Port of Savannah has benefited significantly from that trend. The Port of Hampton Roads certainly has benefited. And we're certainly seeing New York pick up additional traffic as well. And we are running large various station train service from Savanna to Atlanta for example. And we are beginning to see some demand go West of Atlanta from Savanna. 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'll probably see Norfolk traffic going back as far as Chicago.

Okay. Is there any way to quantify in the last six months? Has there been an acceleration of the diversions 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 trends?

I don't indicate that from the first quarter to the second quarter. We actually saw an acceleration of all water conversion to the East Coast ports.

Okay. Can you put a number to that or is that something you don't want to share?

I would rather... for the shipping lines to talk about that; because as we pointed out in the past, we are very much working to promote traffic from both coasts, and we are positioning our ramps and our logistic centers, where we can handle the traffic due through East Coast ports or West Coast ports. And it's 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. So, we are neutral with respect to that. We just want to be in position to serve either coasts.

Got it, thank you very much.

Thank you.

Mr. Moorman, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Well, thank you very much everyone. We look forward to talking to you at the end of the third quarter.

This concludes today's teleconference. You mat disconnect your lines at this time. Thank you for your participation.