Norfolk Southern Corp. Q4 2008 Earnings Call Transcript

| About: Norfolk Southern (NSC)

Norfolk Southern Corp. (NYSE:NSC)

Q4 2008 Earnings Call

January 28, 2009 09:00 am ET


Leanne D. Marilley - Director of Investor Relations

Charles W. Moorman - President and Chief Executive Officer

Donald W. Seale –Chief Marketing Officer

James A. Squires - Chief Financial Officer

Stephen C. Tobias - Chief Operating Officer

Deb H. Butler - Chief Information Officer


Thomas Wadewitz - JPMorgan

Anthony Hatch – Independent Analyst

Steven Kron – Goldman Sachs

Ken Hoexter - BAS-ML

Scott Group - Wolfe Research

Gary Chase - Barclays Capital

William Greene - Morgan Stanley

Walter Spracklin – RBC Capital

Randy Cousins - BMO Capital Markets

John Larkin - Stifel Nicolaus


Greetings and welcome to the Norfolk Southern Corporation fourth quarter earnings conference call. (Operator Instructions) It is now my pleasure to introduce Norfolk Southern's Director of Investor Relations, Ms. Leanne Marilley.

Leanne D. Marilley

Thank you and good morning. Before we begin today's meeting, I would like to mention a few items. First, we remind our listeners and Internet participants that the slides of the presenters are available for your convenience on our website at in the Investor section. Additionally, mp3 downloads of today's meeting will be available on our website for your convenience.

As usual, transcripts of the meeting also will be posted on our website and will be available upon request from our Corporate Communications Department. At the end of the prepared portion of today's call, we will conduct a question-and-answer session and invite those listening via teleconference to participate as well, time permitting. At that time, if you choose to ask a question, an operator will instruct you how to do so from your telephone keypad.

Please be advised that any forward-looking statements made during the course of this presentation represent our best good faith judgment as to what may occur in the future. Statements that are forward-looking can be identified by the use of the word such as believe, expect, anticipate and project. Our actual results may differ materially from those projected and will be subject to a number of risks and uncertainties, some of which may be outside of our control. Please refer to our annual and quarterly reports filed with the SEC for discussions of those risk and uncertainties we view as most important. Additionally, keep in mind that all references to reported results, excluding certain adjustments such as non-GAAP numbers, have been reconciled on our website in the Investors section.

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

Charles W. Moorman

Good morning. It is my privilege to welcome you to our fourth-quarter 2008 analysts’ meeting.

Those of you who are here today will have noticed that we have a number of our management team present and our goal this morning is to provide you with a comprehensive overview of our strategic, operational and financial initiatives. To help do that, we have with us Steve Tobias, our Vice Chairman and Chief Operating Officer; Deb Butler, our Executive Vice President Planning and Chief Information Officer; Jim Hixon, our Executive Vice President of Law and Corporate Relations; Mark Manion, our Executive Vice President Operations; John Rathbone, our Executive Vice President of Administration; Don Seale, Executive Vice President and Chief Marketing Officer; and Jim Squires, Executive Vice President of Finance and Chief Financial Officer. We are also joined by Rob Kesler, our Vice President of Taxation; Bill Romig, our Vice President and Treasurer; Marta Stewart, our Vice President and Controller; Frank Brown, our Assistant Vice President of Corporate Communications; and Debbie Malbon, who is Jim Squires’ assistant.

Since we have a full slate for you this morning, let’s get started. I am very pleased with our 2008 results that reflect a continuing high level of performance throughout our organization, capped by a fourth quarter that reflects the strength of our diverse portfolio of transportation products in the global marketplace.

Our 2008 railway operating revenues were the highest of any year in Norfolk Southern’s history, and we posted our best ever income from railway operations, net income, earnings per share, and our lowest operating ratio ever, which improved 1.5% year-over-year to 71.1%.

Stockholders benefited from a seventh consecutive year of dividend growth, as we increased our 2008 dividends by 27%, and we repurchased over 19.0 million shares of stock.

Throughout the year, we continued to sharpen our customer focus by investing in our network, developing and integrating new technologies to increase reliability, efficiency, and safety.

Our financial results for 2008 demonstrate continued demand for efficient rail transportation, and while economic headwinds continued to exert pressure on traffic volumes, we were able to offset reduced loadings through pricing gains and cost control.

Despite lower overall volumes we produced improvement in revenues, which Don will discuss in greater detail in a moment. We also were able to control operating costs where appropriate given the business environment, while providing increased levels of service. The result was record net income of $1.7 billion, or $4.52 diluted earnings per share, for the year.

In the fourth quarter we faced even more significant challenges as volume declines accelerated on a year-over-year basis. However, we were still able to generate improved financial results and set a number of fourth quarter records, including railway operating revenues, income from railway operations, net income, earnings per share, and our best-ever operating ratio of 67.5.%. And Jim will provide you with the full details of our financial results, including some of the catalysts which drove our fourth quarter performance.

As an indication of our confidence in the strategic direction of our company, the Board increased our quarterly dividend $0.02 per share yesterday, or 6%. Our focus is to continue to produce solid results that benefit our customers and our investors alike.

While it is unclear how long the current economic downturn will persist, all of the long-term trends point to freight railroads as the preferred way to move goods and relieve highway congestion. We will continue to make investments in our company and, as you’ll hear more about today from Deb Butler, in 2009 we plan to invest $1.4 billion in capital improvements to maintain the safety and quality of our franchise, improve operating efficiency and service, and support the business growth we expect in future years.

I’m now going to turn the podium over to Don who will provide additional details about our revenues, followed by Jim, who will delve into our financial results. In addition, I’ve asked Steve to talk with you today about service delivery, and you’ll also hear, as I mentioned, from Deb about our capital plans. I’ll close with some comments before we take your questions.

Donald W. Seale

Despite the current economic headwinds, fourth quarter revenue reached $2.5 billion, an increase of $48.0 million, or 2%, over the fourth quarter of 2007. This was our best fourth quarter ever and our third highest revenue quarter as well.

Primary drivers of these favorable results were improved yield and higher fuel revenue. With respect to fuel, during the fourth quarter we experienced a positive lag effect in fuel surcharge revenue of $130.0 million.

For the year, revenue reached $10.7 billion, up $1.2 billion, or 13%, over 2007. All of our business groups except automotive posted record revenues in 2008. Again, with respect to fuel revenue, the positive lag effect realized in the third and fourth quarters was mostly offset by a negative lag in the first half of the year.

Turning to yield on Slide 3, the fourth quarter represented our 25th consecutive quarter of year-over-year revenue per unit growth and was our third highest quarter ever. Revenue per unit reached $1,450 for the quarter and $1,451 for the year, increases of 10% and 17% respectively.

With the exception of automotive, all other business groups produced record revenue per unit for the quarter. For the year, all business groups achieved record RPU.

Revenue per unit for the fourth quarter was up 10% despite the impact of a volume-related contract adjustment in the fourth quarter of last year, which added $14 to total revenue per unit and $200 per car to automotive RPU.

During the quarter approximately 65% of the RPU gain was due to strong re-pricing and higher contract escalators. Increased fuel revenue accounted for the remaining growth which was partially offset by last year’s contract settlement that I just mentioned, along with a negative mix effect of $61.0 million.

Pricing gains in the quarter averaged 7%, while RCAF rate escalations averaged 2%. For the year, similar results were attained with overall price up 9%, which included the favorable RCAF contract escalations.

Now turning to volume as shown in Slide 4, total shipments were down 8% for the quarter and 3% for the year. Agriculture and coal both posted record volumes for the year, while metals, construction materials and automotive volumes fell as the year progressed and the economy weakened. Paper, chemicals and intermodal volumes were also impacted throughout 2008 by the downturn in consumer spending, weaker manufacturing and the general decline in international shipping activity.

As shown in Slide 5, volumes that were merely soft in October accelerated downward in November and December, led by large declines in steel and automotive traffic. Steel production in the quarter fell by 32% and automotive production was down another 24%, coupled with the closure of three additional assembly plants served by our railroad.

With that overall revenue and volume results as a backdrop, I will now turn to the quarterly performances of our individual market segments, starting with our coal business shown on Slide 6.

For the quarter, coal revenue reached $798.0 million, up $197.0 million, or 33% over last year’s fourth quarter.

Average yield rose to $1,817 per car, up $376, or 26%, driven by continued pricing gains, favorable RCAF contract escalators and increased fuel revenue.

Volume for the quarter was up 5%, led by higher export volume. During the quarter, a new monthly coal tonnage record was set in October, exceeding the prior record set in May 2008 by 4%.

Export volume was up 16% for the quarter and 48% for the year. Through the third quarter export shipments were up 60%, prompted by Australian port capacity constraints and a weaker dollar. During the fourth quarter growth in export shipments trended lower as global steel production declined.

Volume through our Norfolk export terminal declined 4% in the fourth quarter as demand for coking coal fell. Volumes through Baltimore increased by 7,500 carloads, or 94%, due to increased coal availability from the Mon production region and new business gains.

With respect to the utility segment as shown in Slide 8, volume was up 5% in the fourth quarter as a result of higher demand due to new business, stockpile growth, and improved availability of coal as the export market softened. We also secured additional long haul business from Colorado and PRB mines to our markets.

Finally, domestic met traffic benefited from the decline in export coal demand which increased coal supply. We also generated new business from the start-up of the Haverhill, Ohio, coke plant and a spot movement of imported coke.

And finally, industrial coal volume declined 12% due to supply constraints and the slowing industrial economy.

Now turning to the carload business, revenue for our merchandise sector reached $1.2 billion, down $133.0 million, or 10%, in the fourth quarter. Weakness in the automotive and housing sectors plagued our merchandise groups throughout the year and contributed to a 19% volume decline in the fourth quarter.

But, on the plus side, each of our Merchandise groups was successful in improving yield over the year. For the quarter, improved pricing and higher fuel revenue drove an 11% increase in revenue per car.

Now drilling down to the individual markets in merchandise, as shown on Slide 11, automotive’s year-long decline continued in the fourth quarter, with volume falling 31%. During the quarter, two NS-served assembly plants were closed and Ford’s Michigan truck plant was closed for a one-year re-tooling. In total, there were 107 weeks of plant downtime during the fourth quarter.

Chemical traffic declined 18% in the quarter as volume fell across all of our major chemical markets. Volume losses due to plant closures and production cuts accounted for 25% of the volume decline. And lower volumes associated with the housing sector contributed to 46% of the decrease.

As shown in Slide 13, our paper and forest products business also felt the impact of the weak housing market throughout 2008. Lumber volume fell 24% in the fourth quarter, while our paper markets continued to be impacted by production cuts.

Metals & Construction volume saw year-over-year improvements in the first three quarters of the year, but plummeting U.S. and global production drove a 25% decline in volume during the fourth quarter. Iron & steel shipments were down 39%, while coil and scrap volumes fell 41% and 29% respectively after posting gains through the first nine months of the year.

And as shown on Slide 15, agriculture volume fell 6% in the fourth quarter after posting quarterly records in the first three quarters of the year. Weakness in the export market, and reduced volumes to processors in the Midwest drove grain shipments lower, while fertilizer demand weakened in the face of falling grain prices.

On the plus side, our integrated agri fuels market continued to be a bright spot. This market includes ethanol, biodiesel, and related feed stocks. For this year the business grew 44%, or 27,000 carloads. Within the agri fuels market, ethanol shipments were up 38% in the quarter and 33% for the year as we gained access to 32 new ethanol distribution terminals and 8 new production facilities.

Concluding with intermodal, revenue for the quarter of $480.0 million was down $16.0 million, or 3%, from the same period in 2007. Volume fell 5% in the quarter as the weakened domestic economy and declining international trade reduced business levels.

Fourth quarter revenue per unit reached $653, an increase of $13, or 2%. Volume fell 5% in the quarter as the weakened domestic economy and declining international trade reduced business levels.

Turning to the market segments as shown on Slide 17, domestic volume was up 11% in the quarter, driven by new service lanes and highway conversions. We continue to secure new highway business in the eastern markets as beneficial owners realize the true value that intermodal provides versus truck. For the full year 2008 intermodal growth was primarily in local Norfolk Southern lanes, east of the Mississippi River, where we gained more than 50,000 new loads.

Of this total, early Crescent Corridor gains from Atlanta to the Northeast, generated a 13% boost in volume. Several other new services, which included the Meridian Speedway, domestic service at Savannah, Georgia, and new reefer and brokerage business also contributed to this growth.

And, international, premium and triple crown volumes all declined in the quarter in the face of much weaker international trade and reduced consumer demand.

As shown in Slide 18, we are continuing to work on our major intermodal corridor initiatives that will improve service and add capacity to our network, making us even more competitive with truck between major markets.

Work on the Meridian Speedway has progressed well and is expected to be completed in 2010. During the fourth quarter, we converted our eastbound transcontinental international traffic to the Speedway, as we did for domestic transcon traffic in 2007. These changes provide customers with the fastest route from the West Coast to the Southeast.

And as you noticed yesterday, we announced our new Titusville, Florida, terminal opening on February 16 and that will provide us with an improved competitive position in the Orlando and Tampa market.

And also, as announced last fall, we are targeting new services and terminal capacity in our New England market as we progress the Patriot Corridor with our Pan Am—Southern joint venture.

Finally, the Heartland and Crescent Corridor projects will directly target highway conversions. We have completed 35% of our tunnel clearance project on Heartland and have been able to progress this work on schedule while handling record volumes of coal, much of which is moving over this route. We expect completion of this project by mid-2010, which will cut a full day off the schedule between the Port of Hampton Roads and the Ohio Valley. And, as I mentioned a moment ago, new business is already flowing from our speed improvements and ongoing developments of the much larger Crescent Corridor project.

Now looking ahead over the year to come, we all know that 2009 will be challenging but the fundamentals of our diverse set of markets, our strong service product, and new project growth will sustain our business going forward.

The prospects for export coal, while less than 2008, continue to offer promise. Current Lamberts Point tonnage handled in January exceeds the tonnage handled in each of the months of November and December of last year. We see continued opportunity in this market as steel inventories world-wide have diminished and high quality U.S. met coal remains in demand. And while our utility shipments will be impacted by weather and the economy, which they always are, coal availability for utility demand will be higher in 2009, which will be a plus.

With respect to the manufacturing economy, the outlook through the first half of the year is weak at best. We plan to offset some of this softness with continued project growth in our agri fuels and scrubber stone markets and we foresee upcoming opportunities in steel, cement, aggregates, and other construction materials from the economic stimulus package that is pending in Washington.

We are also seeing inventories of most manufactured products shrink in the face of reduced production. We anticipate that restocking efforts will drive improved volumes as the year progresses.

In our intermodal markets, domestic growth remains solid, as I just mentioned. We continue to refine our corridor strategy and will announce new projects and services throughout 2009.

Finally, with respect to pricing, with the decline in oil prices and the lower RCAF index projected for 2009, we do not foresee the robust RPU gains that were achieved in 2008 but while the pricing environment will be more challenging, we will continue our structured and deliberate strategy to appropriately price our strong service product to fully reflect its value in the market place. In that regard, approximately 70% of our book of revenue has been priced for 2009 with the remaining 30% spread over the balance of the year.

With that, thank you for your attention and now Jim will present our financial report.

James A. Squires

I will now provide an overview of our financial results for the fourth quarter as well as a free cash flow and capital structure update.

Let’s start with our operating results. As Don described, railway operating revenues for the quarter were $2.5 billion, up $48.0 million, or 2%. Slide 3 displays the corresponding operating expenses, which decreased by 4% for the quarter. The resulting income from railway operations was $813.0 million, up 19%, and the 67.5% operating ratio is a 6% improvement versus prior year. These results reflect fourth quarter records for Norfolk Southern. In fact, the operating ratio is a record for any quarter.

Turning to our expense detail, this slide presents the major components driving the decrease. As you can see, the largest reason for our overall expense decline was sharply lower fuel costs, which decreased by $84.0 million, or 24%.

This reduction was a combination of lower usage and lower prices. Our consumption for the quarter declined 10%, which compares favorably to the 8% traffic volume decline Don discussed, and correlates to lower train hours. A concerted effort to match locomotive horsepower with specific train requirements has yielded positive results, and this consumption improvement accounted for approximately $38.0 million of the fuel expense decrease.

In addition, lower fuel prices, as illustrated on our next slide, provided a $46.0 million benefit. This graph shows our average price per gallon for each of the last eight quarters. The $2.19 average price in the fourth quarter of 2008 was a 14% decline compared with the $2.56 per gallon in the fourth quarter of 2007.

The other expense category that declined this quarter was compensation and benefits, which decreased by $14.0 million, or 2%. Slide 8 presents the major components driving this change.

First, stock-based compensation fell $43.0 million, due largely to a $19.16 per share decrease in our stock price during the quarter. Second, train and engine crew hours were down in response to the lower volumes. Steve Tobias will review with you some of the train and crew optimization models that have allowed us to respond quickly to changes in the market.

Somewhat offsetting these reductions were incentive compensation and higher wage rates. Incentive compensation for the quarter was $19.0 million higher than last year, reflecting the improved operating results as well as a higher eligible bonus percentage for our union employees. Wage rates were higher by $15.0 million, reflective of the union pay increase that went into effect last July.

Purchased services and rents rose $9.0 million, or 2%. This small increase in a quarter of declining volume was related to several projects that have longer-term effects. The first is expenses related to positive train control technology and the second is an energy conservation project to upgrade lighting efficiency at many of our offices and shops.

The two remaining operating expense categories also reported small increases, $9.0 million, or 5%, for depreciation and, $1.0 million, or 1%, for materials and other.

I would like to point out that within the other category we continued to see positive development in our personal injury accrual, a tribute to and a direct result of our safety program and the employees who make it a part of their daily work. In this particular quarter that improvement was offset by increased environmental remediation costs at existing sites.

Now let’s turn to our non-operating items on Slide 11. Equity in Conrail earnings declined by $18.0 million due to the absence of a federal tax audit settlement that benefited 2007. Gains on property sales and investments were $10.0 million lower this quarter, a result of softening in the real estate market.

Somewhat offsetting these declines were coal royalties, which increased $6.0 million, and the absence of expenses for synthetic fuel investments, the tax credits for which you will recall expired at the end of 2007.

As illustrated here, the combination of the $127.0 million improvement in operating profits and the $20.0 million decline in non-operating items yielded a 17% improvement in pre-tax results.

Income taxes for the fourth quarter were $267.0 million for an effective rate of 37.1%, which compares with $213.0 million, or an effective rate of 34.8%, last year. The increase in the rate for 2008 was primarily due to the absence of the Conrail tax adjustment, as well as the expiration of the synthetic fuel-related credits.

Slide 14 depicts our bottom line results. Net income was a fourth quarter record of $452.0 million, an increase of $53.0 million, or 13%.

Diluted earnings per share were $1.21, which was $0.19 per share, or 19%, above last year.

Wrapping up a record year, 2008 net income of $1.7 billion was $0.25 billion, or 17%, above 2007.

Diluted earnings per share for 2008 were $4.52, which was $0.84 per share, or 23%, more than 2007.

Now I’d like to provide you with an outlook on some of our 2009 expense drivers, as well as an overview of our cash flows and capital structure. Slide 16 highlights some of the key expense drivers that will impact operating expenses in 2009.

First, we have seen a significant decrease in the price of diesel fuel, as noted earlier in this presentation and while we expect that prices may creep somewhat higher compared to the levels we are seeing in January, we do not foresee a return in 2009 to the record high levels experienced in 2008.

Next, contract wage rates will increase in 2009. Most of our union employees will receive a 4.5% wage rate increase as of July 1st.

Third, in 2008 our net pension credit was approximately $40.0 million. There will be no such benefit in 2009, primarily due to the decline in the value of pension assets.

On the volume side we also expect expense reductions, including fewer crew starts and lower fuel consumption, to the extent possible without sacrificing service.

Additionally, we are targeting overtime expenses relating not only to train crew costs, but also to our roadway maintenance and mechanical areas.

And finally, equipment costs are expected to decrease somewhat relative both to car programs and equipment rents.

With respect to cash flows, for the fourth consecutive year, our cash provided by operating activities exceeded $2.0 billion. As you can see, capital spending increased over this same period, however, it remained relatively stable as a percentage of cash from operations. And free cash flow was approximately $1.0 billion in each year; well above historical levels.

This cash was used to repurchase shares, including $229.0 million in the 4th quarter, as well as to increase our dividends. For the time being we have reined in our share purchases as we await additional insight regarding the effects of the economic downturn. We do have the option to acquire an additional 10.0 million shares through 2010 under existing authorities.

Slide 18 depicts some primary measures of financial leverage. Our balance sheet remains very strong, with cash at yearend of $618.0 million, a debt-to-capitalization ratio, including operating leases, of 46.2%, and interest coverage of over 9 times.

In addition, since the end of the year, we have repaid $200.0 million of our receivables securitization and issued $500.0 million of seven-year debt with a yield of 5.83%, and this has further increased our cash on hand.

Looking forward to 2009, we project strong liquidity. We will continue to focus on operating cash flow and especially on cost control in light of the economic situation.

Our access to credit markets is good, as illustrated by the successful debt offering, and Norfolk Southern currently maintains the highest investment grade rating of Class I Railroads in the U. S. In addition, we have access to non-capital markets borrowing such as our accounts receivable facility and commercial paper facility.

Debt maturities in 2009 are $484.0 million, and based on our current capital structure, will decline over the next five years.

Our pension plan, while currently somewhat underfunded, will not require payments until 2010 at the earliest and then only if the value of the plan assets don’t recover.

Norfolk Southern will continue to view dividend commitments as a high priority for distributions of free cash flow and will remain flexible with regard to share repurchases in 2009.

And finally, as Deb Butler will cover with you in more detail, we plan to maintain our commitment to capital spending while still managing the timing of some of these investments in response to economic developments. We have contingency plans in place to reduce capital spending if economic conditions continue to deteriorate.

Thank you for your attention and now, for an update on our operations, I will turn the program over to Steve Tobias.

Stephen C. Tobias

Railroads by design tailor operations for consistent service performance by planning for non-standard events to ensure operational continuity. This includes train plans, maintenance practices, all aspects of the human element, and computer support systems. Over the years we have reported on a number of successful events, examples of our ability to adjust to the unexpected and for the expected.

The economic scenario in the second half of 2008, and especially the final quarter, presented challenges and opportunity to improve service consistency in a volatile business environment. While we, like many, have seen a drop off in car loadings and business levels, the dynamics of our Thoroughbred Operating Plan has enabled us to quickly adjust operations to fit the ebbs, flows, and change of mix as the markets transform.

I will elaborate more in a few moments on what and how of variable operations and cost control, but first, I would like to bring you up to date on our safety performance.

Employee safety is the critical element of all operations. And I know we talk a lot about safety, and we should, because a safe workforce is a consistent one that enables plans to execute as intended. While performance for the 2008 period will not be officially reported until next month, this graph shows comparison with last year.

Our current 2008 injury ratio per 200,000 man hours, shown in green, is 0.93.

In 2009, we are putting even more focus on service. Last year service became a component of our annual bonus calculation and in 2009 we will increase the service component from 20% to 25% of the total bonus calculation. We will also expand calculations for two key components to include more network trains and tighten measurements on connections.

The Service portion of the bonus calculation is based on composite performance. Composite performance is a weighted average of the three primary service component measurements, train performance, connection performance, and plan adherence as depicted at the upper right-hand corner of Slide 3.

As the pronounced reduction in shipments began several months ago, we relied on planning tools within the operating plan to meet our challenging times. Keep in mind that we use these systems everyday and we’re able to maintain consistency of operations while meeting a series of goals as we adjust our rail system to right-size with the evolving economy.

These goals are safety of operations, consistent customer service, and scalable cost control. On all three we have not let up and our TOP system allows us to work all three in concert with each other in virtually near real-time.

Starting in mid-October and accelerating in mid-November, we systematically removed train starts from our operating plan driven by the falling number of shipments.

Over Thanksgiving, we curtailed operations for the first time in over a decade. As traffic volumes continued to fall, we analyzed the plan and took capacity out where traffic could no longer support the existing train plan. At the end of 2008 going into 2009, we had reduced the operating plan by over 60 network trains, plus locals and yard jobs, totaling almost 44,000 train starts.

We also began to reevaluate the switching requirements at terminals on the system, using OPD, or our Operating Plan Developer technology. We were able to quickly analyze and adjust yard operations while continuing to meet customer requirements.

We have been able to substantially reduce the operations at Buckeye Yard in Columbus, Ohio, our yard in Sheffield, Alabama, and Reading, Pennsylvania. We continue to analyze all of our yards and are making adjustments as appropriate.

OPD is at the center of strategic and tactical network planning. With OPD we are able to react to changing traffic patterns and act accordingly. While it is relatively easy to remove trains from the operating plan, it is important to do so and not negatively impact car handling, car miles, car size, and train size.

OPD allows us to do this, evaluating all components simultaneously and making the optimal network decision. In a rapidly changing environment, the ability to migrate from operating plan development to implementation is a significant advantage.

Along with OPD we have also built models to determine the required locomotives and crew base, all dependent on the requirements of the operating plan. We feel our Operating Plan Developer at the moment is a competitive advantage.

In addition to adjustments to the operating plan for trains, we also use OPD to manage equipment assets as business conditions change, and that can be up or down. This slide shows, in orange, our daily number of stored merchandise cars through the end of 2008.

Stored cars are staged at locations that enable quick return to service without excessive handling once market conditions improve. Combined with coal, intermodal, and multilevel equipment, we now have approximately 20,000 cars stored across the network as depicted in the pie chart. Our coal-stored number benefited from efficiencies made in our coal operations that required fewer cars. Our timely car storage focus enables us to right size our car types to customer requirements and minimize our costs.

Further, as the operating plan was reduced, the requirement for locomotives decreased. The red line in this graph represents locomotives operated, while the blue line indicates train hours operated. As you can see train hours and locomotives operated remain relatively constant, albeit with day of week variation, through November of last year.

As we started to make significant reductions to the operating plan throughout November and into December, the requirements for locomotives also declined. Over a two-month period we have reduced in-service locomotives by 127 units,

We constantly monitor our manpower needs throughout our system. Our personnel management systems within the Atlanta Crew Management Center allow us to manage train and engine service needs directly with current operations in connection with marketing forecasts and focused, localized business level projections, all matching the needs and planning geared with the Thoroughbred Operating Plan.

Given the economics, our TOP train plan redesign gradually reduced train counts and crew needs. As a consequence, our active train and engine service employee level gradually declined in 2008, accelerating during the fall and into 2009 with the exception that we continued to find opportunity for our recently hired employees for retention and training.

Early on we slowed train and engine service hiring as some softening in business levels became apparent, notably in the automotive sector, and since December have curtailed it, from a high of 12,380 T&E service employees in April 2008 to a current 11,622 last week. A curtailment in hiring and the furloughing of train and engine service employees drove this reduction.

We began furloughing in October and we anticipate furloughing an addition 100 employees in the next 30 days, bringing the total to over 500 T&E employees. Generally, as reductions in train operations are made, they are followed by reductions in other departments, such as mechanical.

Realizing the benefits we have derived from the technology developed over the last ten years has only reinforced our commitment to the future opportunity. UTCS, LEADER, Pacesetter, and LARS are only four of our current initiatives that will improve our operation, our service delivery, and help us reduce our costs. There are many others in the capital planning and pilot stage.

Deb Butler will now cover the capital budget and some related technology issues.

We are all concerned about the volatility in the marketplace, like everyone, but as you can see, reacting responsibly. We are able to act, and will act, on circumstances as they evolve.

Deb H. Butler

The next several slides are intended to add a little color to Norfolk Southern’s 2009 capital expenditure plans.

Due to the uncertainty of the economy, we plan to spend less in 2009 than we did in 2008, and as Jim mentioned, we have already identified projects within the current 2009 plan that could be postponed if business conditions are substantially worse than forecast and spending needs to be adjusted further.

However, our planned 2009 capital budget includes investments, both to maintain the safety and quality of our existing franchise, and to support the business growth we continue to expect in future years. Investments in service quality and performance, especially in the Intermodal market area, have been, and will remain, key drivers of growth. And we will continue to look toward public-private partnerships as one method to help finance these improvements.

Total planned capital investment in 2009 is $1.412 billion compared with $1.56 billion in 2008 capital spending.

Each year a significant portion of our capital expenditures is invested to maintain our franchise, including upgrading the condition of our right-of-way, replacing equipment, and complying with safety and regulatory requirements.

As shown on Slide 4, approximately 72% of our 2009 capital expenditures will be spent on maintaining our railroad for continued safe and reliable operations. The remaining 28% of our budget is related to the growth and productivity of our franchise. These projects include infrastructure and terminal expansion investments, strategic opportunities, and projects that improve our productivity and efficiency.

The categories of capital expenditures we plan to make in 2009 are highlighted here. I’ll provide some detail for each of these types of investments in the next few slides.

A large part of our budget is spent to maintain our existing franchise and a significant portion of that is needed to keep our right-of-way in the condition needed to move our customers’ business safely and reliably. Roadway spending in 2009 is budgeted to be $698.0 million, or 49% of our total capital budget.

Our 2009 roadway budget contains funding for the normalized replacement of rail, ties, and ballast, as well as for the continued improvement or replacement of bridges located throughout our system. Program spending is projected to be 13% higher than 2008 spending, although our plans to replace rail, crossties, and ballast are all slightly below 2008 levels on a unit basis.

The increase in roadway spending in 2009 is primarily due to increased unit cost projections. These costs are a moving target in today’s environment and we will adjust our spending throughout 2009 to reflect actual costs. However, due to the long lead times required, roughly two-thirds of the material needed to support the 2009 programs has already been purchased or committed.

Freight car acquisitions and improvements will total $45.0 million, or 3% of our expected capital expenditures this year.

As shown on Slide 9, in 2009 we plan to acquire 514 newly-built super jumbo covered hoppers to protect our core southeastern feed grain business. These cars replace more expensive leased cars that we will turn back, and as a result, the project has very attractive returns.

To maintain capacity in certain freight car fleets where we expect high demand in future years we plan to buy out the leases of 331 freight cars as their leases expire in 2009.

And as Steve mentioned, we are reaping the benefits of several 2008 initiatives, including the scheduling of unit coal trains that significantly improve the velocity of our coal car fleet. Although we are still faced with replacement of a large percentage of our coal fleet over the next several years we will be able to defer new coal car purchases until 2010 and later years.

Locomotive spending will total $79.0 million, or 6% of our expected capital expenditures this year. We do not plan to acquire new locomotives in 2009, due partly to aggressive spending in previous years, and partly to asset utilization improvements. We will, however, continue to make capital improvements to the fleet to maintain capacity and improve efficiency and reliability.

Emission kits for both GE and EMD locomotives will be installed to meet government requirements. We will invest in Communication Management Units, which are GPS locomotive information systems that are central to a number of our Track 2012 initiatives, including positive train control.

Hybrid initiatives include the construction of a six-axle locomotive with lead acid power plants to be used for pusher service in the State of Pennsylvania and the construction of several Genset locomotives for local switching.

As shown on Slide 12, investments in facilities and terminals throughout our network will total $141.0 million, or 10% of our total planned capital expenditures.

We expect intermodal to be a high growth market over the long term and we will continue to invest in intermodal terminal capacity. This was our strategy during the lean recession years in 2002 and early 2003 and it positioned us well when traffic growth resumed.

Investments to support other marketing initiatives include facilities for moving ethanol and municipal solid waste.

Non-commercial facility investments include new locomotive facilities in Pittsburgh, Pennsylvania, and Atlanta, George, the renovation of several buildings used by transportation and mechanical forces, and new or upgraded wastewater treatment plants.

Investments in computers and technology are budgeted to be $67.0 million, or 5% of our total capital expenditures. We invest in technology to enhance safety, to improve operational efficiency and equipment utilization, and to give us the tools to better plan and manage our network and processes. All of these investments are targeted to help us meet our Track 2012 goals.

As shown on Slide 15, projects that will be funded next year include the continued roll-out of Optimized Train Control. That’s Norfolk Southern’s version of positive train control. Also LEADER, a locomotive engineer coaching system that is expected to yield fuel savings and to reduce equipment wear and tear as a result of better train handling. Also UTCS, our new dispatching system.

Several new and replacement investments are budgeted in order to maintain our core systems and to provide new planning tools to assist in improving yard, crew, train, locomotive and freight car performance.

Investments in infrastructure are budgeted to be $170.0 million, or 12% of our total capital expenditures. Most of the infrastructure investments planned for 2009 are projects to increase mainline capacity, to improve the network to accommodate future traffic growth, and to support public/private partnerships, such as the Heartland and Crescent Corridors and the Chicago CREATE project.

Crescent Corridor investments include the 2009 spending required to complete our matching obligation of the Virginia Commonwealth funds for capital improvements along the Crescent Corridor in Virginia.

Projects that fall outside of the categories I’ve previously described total $213.0 million, or 15% of our planned capital expenditures in 2009. Included in this category are core investments such as the replacement of roadway machinery and vehicles, communications and signal projects, and public improvements such as grade crossing separations. Also included is funding for projects that require capital investments of less than $500,000 per project.

To summarize, the $1.412 billion to be spent on 2009 capital investments represents a decrease of $144.0 million, or 9%, compared with 2008 capital spending. As always, business needs, the economic environment, and strategic initiatives such as Track 2012 are the key drivers of our capital investment decisions.

Thank you and I’ll turn the program back over to Wick.

Charles W. Moorman

Well obviously, 2008 was a terrific year for Norfolk Southern. We were pleased with our performance, especially in the light of reduced volumes and the economic uncertainty, and we remain confident in the strength of our franchise going forward.

Looking ahead, it goes without saying that we’re looking at a set of business conditions and an economic outlook that are as troubled and uncertain as anything we have seen in many, many years.

As you will have seen, January carloadings continue to be down substantially and there is little doubt that our first quarter and full year 2009 earnings will be under pressure, barring some unforeseen improvements in the economy.

To manage through this environment, we will remain focused on a few key principles. First, we will obviously continue to control costs to the fullest extent possible without negatively impacting customer service. As you all know, Norfolk Southern has a long history of effective cost control and Steve showed you how we have the tools to respond quickly to changing traffic conditions.

Second, as you’ve heard this morning, guided by our Track 2012 process, we will continue to take a long-term perspective as we enhance our new traffic corridors, improve our technology, and support our operations with the tools necessary to provide superior service. We’ll keep our property and assets maintained at a level that will allow us to provide that service.

This recession will end someday, and just as in 2003, we’ll be positioned to take full advantage of all of our opportunities when it ends.

Third, we’ll continue to aggressively pursue new business development plans and products, such as our just-announced Chicago-Titusville, Florida service. Economic disruption will create business opportunities for us, and we will take full advantage of them and we will also continue to make sure that we realize the full value of our superior service products.

2009 will present significant challenges for Norfolk Southern, but let me conclude by saying that I am as optimistic as I have ever been about the longer-term prospects for our company. All of the structural reasons for our success in recent years are still in place, if somewhat masked by current economic conditions, and when the economy recovers our combination of superior service, at a cost that makes sense, along with a superior environmental footprint, will make us the preferred transportation solution.

Thank you for your patience. We have obviously given you a lot of information today. I really can’t imagine that you would have any questions left at the end of this, but I see hands going up already and I will first take questions from here in the audience and then I will turn the program over to the operator who will handle the questions by telephone.

Question-and-Answer Session

Thomas Wadewitz - JPMorgan

Don, you made a comment about pricing being more challenged but you also said that there are some negative impacts on yields, which are fairly evident in terms of the lower fuel surcharge and I think RCAF, when you look at it with respect to fuel, it was a big driver to move up and so obviously fuel causes it to go down. What did you mean by the pricing is more challenging, and if you strip out fuel and strip out RCAF do you think the trend in core pricing, if you will, is really going to change a lot, looking forward?

Donald W. Seale

With respect to RPU, the statement that I made is we don’t expect the robust RPU gains in 2009 that we saw in 2008. Lower fuel revenue will be a component of that, the lower RCAF will be a component of that. But as I mentioned, when we look at price in the fourth quarter, and for the year, we averaged about 7% on price and about 2% favorable in the fourth quarter on the RCAF.

We have 70% of the book of business repriced for 2009. We are satisfied with the pricing that was obtained in that 70%. So while we are looking at the market, obviously the market that we are facing in 2009 is a more challenging market than we faced at the beginning of 2008. There’s no doubt about that. I think we are all in agreement there.

In terms of the fundamentals of pricing, we are going to continue to be very deliberate, use the strategy that we have deployed in the past, make sure it matches the value proposition, and service product that we are delivering, which is a good one.

Thomas Wadewitz - JPMorgan

I guess another component within that would be the impact of coal contract expirations were favorable in 2008, as you looked at 2009 do you have more benefit from coal contracts which you can price up to a large extent, and I was wondering if you could compare the impact in 2009 versus what it would have been in 2008.

Donald W. Seale

We have a comparable year in 2009 to 2008. We did some repricing of some fairly significant coal contracts in August of 2008, which will continue to run, obviously, through 2009. These are longer-term contracts. We also have some new prices go into effect January 1, on some coal contracts. So in terms of the overall impact of coal contract pricing, comparable result in 2009 to what we saw in 2008.

Thomas Wadewitz - JPMorgan

Any quick comment you can make on volumes recently and on production? That restarting of plants. I think one of the other railroads said volumes were off only 7% to 8% in the last week versus maybe down 25% in the quarter. I was wondering if you are seeing any improvement in the most recent data that is not quite as grim as the prior data.

Donald W. Seale

With respect to volume, that truly is the wild card, with respect to 2009. Frankly, we didn’t expect the first two or three weeks of January to be robust. A lot of plants took down time. Chrysler took a full month of down time, which was announced back in December.

So we expected volumes in automotive, metals, chemicals, some of those products, to be fairly low in the first two or three weeks. So far through January, volumes are weak at best. I think those three sectors that I just mentioned are the sectors that are probably ones to watch. We are seeing inventories in steel, for example, based on our observation, beginning to come down.

We have seen the scrap price, which is a pretty good proxy, which was about $550 a ton back in June/July, it got as low as $90. Now scrap prices are beginning to go back up. They’re up to about $140 to $145. Not back to the $550 level, but it’s beginning to show that there is a rebound. And we know inventories are being pulled down because steel production was cut substantially in the fourth quarter. So we know that eventually those inventories are going to have to be restocked.

We are seeing some of that in the global steel market, and I mentioned export coal. Our export coal for January, our loadings, are going to almost equal the export loadings that we saw in November/December combined. That tells us that there is some fundamental reach-back of coke making in Europe, for example, the is beginning to rebound a little bit.

Now I can’t read too much into that and I would prefer that you not read too much into it, either, because that’s only one month.

Charles W. Moorman

Someone asked me earlier how our crystal ball was. We have always said it’s cloudy. It’s gone opaque on us. We are looking at this economy in the same way everyone else is and watching, but as Don said, we fully expected the first few weeks of the year to be very slow us, and for the economy, and they have been.

Anthony Hatch – Independent Analyst

Where do you see the government scene shaking out? And what I am specifically referring to is the stimulus bill and the potential transportation bill reauthorization later this year and how that may shake out for you and for the industry and compare that to state government budgets, which are obviously hurt and we have heard bad things about Virginia, which is important to your projects. I don’t know if that affects that so I was wondering how does that shake out for your various corridor projects and other things you have where you are counting on public support?

Charles W. Moorman

In terms of the stimulus package and whatever it evolves to be, clearly it’s in a state of flux.

And then the reauthorization of the highway bill, which will be later this year and might possibly go into next year, we’re still out making our case as aggressively as we possibly can, that some of our projects, the Crescent Corridor being a prime example, are absolutely terrific public/private partnerships that will relieve highway congestion, relieve a lot of pressure on highway spending, and have a lot of public benefits.

And I will tell you, we talk to a lot of folks about them, and universally, they get it. Now, how that translates ultimately into funding, we’ll have to see.

In terms of the stimulus package, the term of art obviously is shovel-ready. We do have shovel-ready projects. Some are Crescent Corridor-related, some are other infrastructure projects. There are some substantial projects in CREATE, which are shovel-ready, which have benefits for the rail network and Amtrak and Metro, as well.

So we are working, more with the states than the federal government, on the stimulus package just because it will be the states that ultimately decide upon their priorities and the distribution of money. We will see where that comes out as well.

You mentioned the State of Virginia, the State of Virginia authorized $40.0 million last year for Crescent-related projects and those projects are underway and in fact, two or three of them have now been completed. And that really leads to what we tell people is a significant advantage for rail projects and that is we can, because we have right-of-way, because the projects do not have the environmental issues that a big road project has, we can go on them much, much faster than most highway construction.

An example of that is the Heartland Corridor, where we are substantially along on that, as Don mentioned. If you look back at the projects authorized in the last highway bill, the projects of national significance, we are one of very few that have progressed in the way that the Heartland Corridor has progressed. So there is a great story there, I think.

Anthony Hatch – Independent Analyst

So you want to net that out against rereg stuff, since you’re talking about Washington?

Charles W. Moorman

I have no idea. Rereg obviously is a topic that will be discussed and we, along with all the other railroads and the AAR and lot of other allies are up making the case that it’s just a terrible idea.

And there are a lot of folks in Washington who know that. So we will continue to talk about those issues. You can talk to Jim Hixon a little more later and he’s leading the charge for us up there.

Anthony Hatch – Independent Analyst

What would you say your variable cost percentage is, that is if you expected volume, if you just picked a random number of 5% drop for the year-over-year, where would your cost ex price, those market factors, drop? And where is it now and where will these new tools get you to? How are you improving that?

Stephen C. Tobias

I am loathe to give you much that you can put in your model. Just as a general matter of principle. I’m really not comfortable giving you a percentage on a specific business drop because, as Wick pointed out, the crystal ball, if it’s not opaque it’s certainly beginning to wizard a little bit.

What’s in your projected 5% decrease is something we would have to look at from a mix standpoint in a real term. But in a general sense, somewhere between 30% and 50% of our costs I would put in a category of variable, from a bucket standpoint. We have to weigh that against the realities of the operation and what business actually does, ebb, flow, and mix change.

Anthony Hatch – Independent Analyst

[Question indistinguishable]

Stephen C. Tobias

It depends on the volume, it depends on the business mix and what that evolution takes place. As I said in my presentation, we are increasingly getting closer and closer to real-time from a standpoint of being able to modify our operations based on what’s going in the market place.

And we are constantly working this. It’s not a well, we’ll do this and get the result in two weeks, it’s a now thing. It would be herculean and very difficult to jump into the system and completely redesign the whole entity of what we do operationally.

But from a micro standpoint, we are able to work it on a daily basis and make changes as we go that affect entire flows and corridors. And that, in the long run, helps us take cost out when we are in a decreasing environment like we are today.

Charles W. Moorman

If you look at our tools and what we think helps us with our tools, the first, as Steve mentioned, is that we have the ability to go in and very quickly make operational changes and weigh as we make them, all of the trade-offs that might add costs, in terms of additional car miles, in terms of additional switching.

Because when you take trains out, you can very quickly ramp up the time cars spend on the railroad, your locomotive requirements and things like. So we have tools that now allow us to respond very quickly.

The other thing, as Steve showed you, and where I think our tools are really good, is on things like crews and labor is giving us a very good way to look ahead and look ahead out over the period of a year or two and decide what we need to be doing in terms of hiring.

We saw volumes start to fall off year-over-year, as you know, in 2007 and really started back then to adjust our T&E hiring down. And we have adjusted it down all the way through but at the same time also tried to retain the people we had hired.

And we have talked about that before. We tried to make sure to enable them to at least have enough work to stay with us because we invest a lot of money to train people.

When we reach the point, as you saw, with the precipitous declines in volumes in the fourth quarter, that we felt it was no longer economically justified to do that, we took the appropriate steps. But it’s that look-ahead capability of our tools that I think is so important.

Steven Kron – Goldman Sachs

You had mentioned on the coal business, restocking of stock piles. Could you give us a sense in terms of where the stock piles are? North or South?

Donald W. Seale

In our utility universe the Northern utilities are slightly below target. I won’t give you a percentage, but they are below target, and we know the plants that are. In the South, they were at target but with the weather patterns that we’re having, they’re beginning to move down a little bit.

Coal availability, as I mentioned, is better. That is if production stays up. We are seeing some of the suppliers, PRB namely one, beginning to ratchet production down. So that remains to be a little bit of something that has to evolve. But coal availability is better right now. Pricing of coal, in some cases, is better. And we are seeing utilities reach out and buy coal and we’re beginning to move that coal at a little bit better pace.

When the export market this past year was so robust, we literally saw some coal constraints and I think some pricing constraints and some of the utilities stayed on the side line as a result of if production stays up. we ttle bit.the weather patterns that we'lants that are. in .d way to look ahead and look ahead out

Steven Kron – Goldman Sachs

On intermodal, I was a little surprised to see the domestic business up year-over-year, particularly given that diesel prices had fallen so significantly. I would have expected that trucks would have come back more competitively. Can you talk about the pricing environment and obviously you have the capital project that you’ve invested in, but it seemed to be a surprising result in a declining fuel environment.

Donald W. Seale

Well, as I mentioned in the comments, and you have heard us talk about this before, we have a very clear-cut strategy of continuing to build our capability east of the Mississippi in terms of our local network. New facilities, new ramps, like the Rickenbacker intermodal terminal. We positioned that facility to handle domestic freight as well as international freight from either coast. So we are trying to be as flexible as we can be.

Now, we are seeing our truckload partners in the domestic intermodal market not waiver at all, in today’s environment, with respect to their ongoing objectives of converting highway freight to rail.

I think that there are a couple of drivers to that. One, no one believes that fuel is going to stay down. No one believes that highway congestion is going to mitigate. It’s going to get worse. No one believes that the demographics are going to reverse and that drivers are going to be plentiful. And then a lot of the receivers, Walmart, Target, a lot of the beneficial owners, are clearly placing in their specs for transportation a reduced carbon footprint. And intermodal fits that bill.

So even in today’s environment where we have truck supply rising and truck pricing dipping in a lot of markets, we are seeing our truckload partners stay engaged with that strategy that we have deployed together.

And you will continue to see us roll out new services, too. The Titusville facility and the Chicago-Florida, L.A.-Florida, Atlanta-Florida market as an example.

And you will continue to see us get benefits from the Crescent Corridor speedwork that we’re doing. We’re incrementally doing speed enhancements along those corridors, and as we have indicated to you in the past, that’s not going to be a project that is done overnight. It will be done over a period of time. It’s a very large project with a large opportunity attached to it.

Steven Kron – Goldman Sachs

Can you just talk about the pricing differential between you and truck? And you talked about short haul, is short getting shorter? I’m assuming it’s 500 miles but maybe you can give us a sense in terms of that domestic short-haul business.

Stephen C. Tobias

We used to talk about rule of thumb of length of haul of x, and generally rail transportation, rail intermodal was 500 miles and north, above. We have corridors today, and I think I have mentioned these to you in the past, for example, the international and domestic market out of the Savannah market, going to Atlanta, that was a market that if five years ago we looked at it as a short-haul market that was truck-dominated.

Today, with a good efficient service and double-stack configuration, with the right size train, we are very productive in that lane and we are able to compete and make the kind of margins that we’re after in the business.

So the rule of 500 is changing and I would submit to you that that will continue to evolve and change over time. As trucking becomes more expensive over time.

Charles W. Moorman

When we look at our franchise, we believe that in the future, while international intermodal will come back as the recession ends, and we are well positioned to handle that business, whether it comes in through West Coast ports or East Coast ports, as we’ve told you, but we really look at domestic truckload freight as the next great opportunity and that’s why we’re talking about all the franchise enhancements, in terms of our corridor projects.

And I have to tell you, we think we are very well positioned to take a lot of truckload freight off the highway and take it at profitable rates for us, even in the shorter haul lanes. It’s a big strategic direction for us.

Ken Hoexter - BAS-ML

Don, you mentioned the auto yields were impacted by $200 per car gain last year because of volume commitment. Could you refresh our memory on that a little bit? Was it that the auto carriers last year didn’t meet volume commitment so you got a better take-or-pay kind of contract? And then obviously this year, if volumes are down as much as they are, did that take-or-pay agreement go away? I’m just wondering why there was that mark to market last year?

Donald W. Seale

As you might recall, this was a contract volume adjustment in the fourth quarter of last year to the tune of about $26.0 million. It was per car numbers, the $200 for automotive in the fourth quarter last year. It was a one-time adjustment.

Ken Hoexter - BAS-ML

So ex that, what would auto yields have looked like?

Donald W. Seale

Obviously they would have been much better. We had that comp. Maybe Marta can give us that number, she’s looking it up. But I didn’t go back and take that out.

Ken Hoexter - BAS-ML

And similarly, intermodal yields were much lower than the rest. Is that just because they are priced more frequently? I’m just wondering if it was more on the domestic side relative to the international side. Aren’t the international contracts having [platers] as well, built in for a few years?

Donald W. Seale

You are referring to yield and I want to make sure that you are referring to the RPU, which is equal to the yield. That is the definition you’re giving that. And as you know, on intermodal we have intermodal fuel surcharges marking to on-highway diesel fuel prices and they change weekly. We have a 60-day lag on the other business, which is coal and merchandise, related to the West Texas Intermediate Crude Oil Price. So, intermodal fuel surcharges move quicker than the 60-day lag in the other. And that’s the difference in terms of the overall RPU delta.

Also, we had a mix effect in the intermodal. We handled a fewer number of trailers. Triple crown was down due to the automotive production cut. And that was a negative mix and we handled fewer trailers and a higher number of domestic containers, which have a lower RPU but a good margin. So we had a mix effect. And that mix was included in that negative $61.0 million mix effected for the quarter for the total book of business. For the entire book.

Ken Hoexter - BAS-ML

And refresh my memory. I believe it was last year you had adjusted your fuel surcharge up to rebasing up to $60.0, which allowed some of the yields to be very impressive over the last couple of quarters. What percent of business is impacted by that rebasing to $60 and how much has been done and how much do you still aim to do?

Donald W. Seale

At the end of the year we have about 95% of our total book of business with a fuel surcharge. And I have to tell you that we have a variety of fuel surcharges negotiated in contracts and different rate items. So we have 95% coverage on a number of different types of fuel surcharges.

Ken Hoexter - BAS-ML

So specifically dealing with that, wasn’t there a $60 dollar rebasing of fuel and what percentage of freight did that impact?

Donald W. Seale

What I’m saying is we’ve had different fuel levels negotiated and I couldn’t really give you a percentage because frankly, it varies between businesses, volumes, etc. So I really can’t get into the percentage at a certain level because we have numerous fuel surcharges.

But the coverage is the key thing. Is that we’ve been able to get up to that level at 95% and by the end of 2009, we should be able to tell you that we’ve been able to get that much closer to 100%.

Ken Hoexter - BAS-ML

I thought that $60 was perhaps on something public, like all of your tariff business. I thought it was a public number.

Donald W. Seale

As you may all recall, we have no fuel surcharge on our public tariff prices. We have no fuel surcharge whatsoever. On our originated public prices. We take the prices, adjust those to market and that’s how we have been able to manage that business.

Ken Hoexter - BAS-ML

And then what percent of business is that?

Donald W. Seale

It’s about 6% of our book, in terms of originations. And then we have another approximately 5% on a received basis but that is using the originating carrier’s fuel surcharge that originates the freight coming to us.

So the answer to your question is about 6% of our book is public prices.

Ken Hoexter - BAS-ML

Have you ever delineated the difference on whether it’s revenue per car or margin basis between our utility and export coal and if you’re not going to give an exact number, can you kind of put it in a ballpark and maybe walk us through. I guess the perception out there is that utility coal is massively more profitable, much higher revenue per car, and the potential loss of the met coal business coming up in the year ahead, or perceived decrease for steel demand, is going to cause met coal . . .

Donald W. Seale

I think you misspoke. You said the perception was utility. Do you mean the perception is export?

Ken Hoexter - BAS-ML

Export, thank you.

Donald W. Seale

I will tell you, from a margin standpoint, they are both very good businesses for us. We are happy to haul coal wherever people want it hauled. The only difference, I would say, between them is the export coal is done slightly longer haul than our average.

Our export book is about 430 miles per car, on average. And if you back that business out, our utility and everything else, domestic met, utility and industrial coal, is about 235 miles. So there is a big delta between the length of haul in export versus the rest of coal.

Scott Group - Wolfe Research

Don, can we back to your commentary on pricing and can you run us through the price, fuel, and mix impact? How much is pure price and how much is RCAF in there?

Donald W. Seale

The RPU was up in the quarter 10%. 65% of that 10% came from price. And out of that price there was 7% pure price, 2% was the effect of the positive RCAF adjustment. And that’s pretty much what we have seen throughout 2008, a +2% RCAF, which we foresee that going down in 2009 because of falling oil prices. So pure price 7%, RCAF 2%.

Scott Group - Wolfe Research

That RCAF, that does include RCAF with fuel?

Donald W. Seale

That RCAF, with the way we have it applied in our contracts, and the RCAF in our book of business is generally more related to coal than some of the other businesses, a percentage of the RCAF has been backed out in a negotiation, to take fuel out of the RCAF. And then a negotiated fuel surcharge applies in conjunction with that adjusted RCAF for fuel.

Scott Group - Wolfe Research

But to the extent that you have any RCAF that is old legacy contracts that have RCAF with fuel in them, is that total RCAF getting put in what you are calling the 6.5% price?

Donald W. Seale

We do not have any appreciable business left with just RCAF with fuel in it.

Scott Group - Wolfe Research

I don’t necessarily understand why RCAF, exclusive of fuel, is going to be down next year. And then why that would have an impact on what you call pure price.

Donald W. Seale

On terms of pure price, and that’s why I segment it to 7% and 2%, with respect to pure price, it will be a separate relationship. But in terms of total RPU growth, our downward movement in RPU, you will see the impact of that negative RCAF.

Scott Group - Wolfe Research

The tough comp with the auto contract issue, is that reflected in lower pure price gains this quarter, meaning the 6.5% versus the 9.5% last quarter? Is that one of the factors that is driving that deceleration? And maybe what else do you think is driving that deceleration?

Donald W. Seale

In terms of the total yield, our RPU for automotive, the RPU for automotive was impacted negatively this year because of that comp from last year.

Scott Group - Wolfe Research

Export coal, you mentioned would be down versus 2008. Do you think it could be back down to 2007 levels, or still above 2007?

Donald W. Seale

We have no good visibility on that total volume. We have some contracts in place. Those are good contracts. The toggle, or the variable, is how much steel production comes back in the Europe. So it’s an interdependent. It also has implications in terms of currency exchange, what our currency does vis-à-vis the Euro, etc. Also, ocean shipping rates, what the Australians do. There are a lot of moving parts in the export market. But I would say at this point, the number one variable in volume is the world steel production.

Scott Group - Wolfe Research

You mentioned that January was up versus November and December. Can you compare it with January in 2008 and January in 2007?

Donald W. Seale

Our volumes at Lambert’s Point in Baltimore will be comparable. They won’t be the same but they will be comparable, to the January 2008 numbers.

Scott Group - Wolfe Research

Headcount was up slightly in the quarter on volumes down 8%. We saw the slides, obviously you took out a lot more heads later in the quarter so it wasn’t fully reflected in the averages. Can you give a sense on where we stand in first quarter year-over-year headcount?

Charles W. Moorman

First quarter, with all the furloughs you’ve seen, we’re down year-over-year. We were up slightly in the fourth quarter, that was driven primarily by the fact that we, as we showed you, tried to maintain T&E headcount about where it had been for a while and we had continued in 2008 to bring in a substantial number of new trainees primarily for our operating department. I have talked before about some of the demographic issues that we face. And we felt, and still feel, it’s important for us to have enough people in the pipeline. And that’s what drove the year-over-year increase.

Scott Group - Wolfe Research

But you’re down year-over-year in first quarter by?

Charles W. Moorman

I don’t have the exact number but clearly with the furloughs we’re down.

Gary Chase - Barclays Capital

Don, if you think about the 2% you highlighted in the quarter and you look at what that index did during 2008, it feels like about 10% of the overall business. Is that a good ballpark for what you are exposed to for RCAF, inclusive of fuel?

Donald W. Seale

As I mentioned, the majority of our business does not have any relativity to the RCAF. The intermodal generally, not much, some but not much. The merchandise, the carload sector, some but not much and some of the older coal contracts have that in there. So the number that you’re citing sounds high to me, because of that.

Gary Chase - Barclays Capital

And then for the business that isn’t exposed to that, do you have a way to size for us what the exposure is to the index, exclusive to fuel?

Donald W. Seale

No, because those are contractual terms and frankly, those are things that are put into place in confidence and we can’t share those. I will tell you this, that the number of RCAF-related contracts are diminishing as we go forward. It’s a shrinking percentage, and it will continue to shrink as we have legacy contracts roll over and turn over and they are renegotiated.

We are putting escalators in that are a little bit more predictable with less variability up and down. And that is good for us and it’s good for the customer in terms of being able to plan.

Gary Chase - Barclays Capital

I think you said it as well during the fourth quarter you had an equivalent weeks shut down, within the auto business. Can you give us a sense of what you are expecting that to be in the first quarter?

Donald W. Seale

That’s a great question and I wish I knew the answer. We had 107 weeks of production down time in the fourth quarter. We know that looking into 2009, if you look at Ward’s Automotive and look at the data, and this is just data that we’re getting from the same sources that you would get production and sales numbers from, and then talking to our accounts, it looks like auto production is going to be down to about 12.0 million units in the U.S. and sales are going to be somewhere in the range of $10.2 million. Those are very weak numbers.

Now, will that change? You are probably seeing the same thing I am, that already the consumer is beginning to turn away from small cars and they are buying large vehicles again. And the producers have turned the production off on the large vehicles and are producing small ones. So, stay tuned I guess is the best answer.


(Operator Instructions)Your next question comes from William Greene - Morgan Stanley.

William Greene - Morgan Stanley

Are you seeing more push back in your pricing discussions because of the economy or are you feeling actually a little bit less from customers, given how much the fuel surcharges have come in?

Charles W. Moorman

I would say we are seeing a little push back in a few places, not an extraordinary amount. We will continue to monitor that. We will continue to talk to our customers and respond accordingly, when a request comes in.

William Greene - Morgan Stanley

As you looked at 2009 I think it’s a fair assumption that if the volume pressure continue as you mentioned, you will be challenged, I think, on the earnings front? Which could very well mean that you fall below the cost of capital on a return basis. Does that reset the clock on revenue adequacy from your perspective?

Charles W. Moorman

That’s a very interesting question that we do not really know the answer to, nor would I say to the STB. Clearly the question of revenue adequacy is out there and we will continue to discuss it.

Having said that, our hope and expectation is that we will continue to earn our cost of capital in 2009 and that is what we are intent on doing. But that is a great question.


Your next question comes from Walter Spracklin – RBC Capital.

Walter Spracklin – RBC Capital

Deb, you gave a good breakdown of your capex program and if you look at that 28% that you mentioned was on the growth productivity, clearly if the economy does stay down or get worse, clearly I don’t think you are going to wipe out that full 28% but maybe you could give us a sense of priority, what kind of levels would see it drop on an incremental basis, depending on how the economy unfolds.

Charles W. Moorman

Deb just empowered me to answer that question. When we did the budget initially went through and identified 15% that we could go in and take out, and it was a combination of some in the 28% bracket and some in the core bracket. Clearly, we would be able to do that but it’s also very clear that if economic conditions were to deteriorate even further and we became concerned, we would be able to cut more out of the budget.

The fact of the matter is that our property is in good shape, and we want to maintain it accordingly but if we have to flex a little bit in the spending, we can do that. The downside of that, and we have seen this in the industry and talked to you about it, it’s very difficult to play catch up. So if we can avoid doing that we will. We think playing catch up ultimately costs you more money than you save.

Walter Spracklin – RBC Capital

On the free cash flow trends, you talked about scaling back down on your share buyback. Can you give some commentary as to your balance sheet? I know you did give a sense of your cash and what was coming up. Specifically how do you look at your balance sheet in terms of where your comfort level is if you have any targets, debt to total capitalization? And as a follow up to that, what do you have left in your securitized receivables? I know you paid down $200.0 million. What’s left in securitized receivables?

James A. Squires

First of all, in terms of our credit metrics, our leverage levels have been pretty constant for the last several years. And I think right now our goal is to maintain our credit ratios at about where they are, for the time being.

In terms of the AR facility, we have $100.0 million drawn. As I mentioned, we paid down $200.0 million, just after our $500.0 million notes issuance. And we have total capacity under the AR facility at any given time of between $300.0 million and $400.0 million generally. So about $200.0 million to $300.0 million capacity there now.

Walter Spracklin – RBC Capital

And that will flow through the balance sheet as debt repayment?

James A. Squires


Walter Spracklin – RBC Capital

The tax rate up last year versus 2007, any sense what we should be plugging in our models for 2009?

James A. Squires

In the fourth quarter the increase was about equally due to the roll off of the synthetic fuel credits in 2007. That and the absence of the Conrail adjustment were each about half of the increase in the effective rate.


Your next question comes from Randy Cousins - BMO Capital Markets.

Randy Cousins - BMO Capital Markets

Don, with reference to your slide that has got RPU on it, last year you had a $399 increase in RPU in your coal franchise. Everybody has got different views of what is going to happen with met coal or met coal pricing, but could you give us some granularity in terms of that $399 increase? How much of it was due to mix, what would you attribute to fuel, what would you classify as repricing of contract and how much would you put in as RCAF? At least for the coal component?

Donald W. Seale

You just covered all the components of that increase. I will remind everyone that the length of haul for export, as I mentioned, is longer so the revenue per car, for export, is higher than the revenue per car generally for the lower mileaged other coal. So that boost RPU. We have a favorable RCAF, which we have talked about, quite a bit. And then we had some other favorable mix. Export was up 48% for the year. After being up 25% in 2007. So we have had a good run on export and that is a higher RPU. And we had pricing gains wrapped into that, too. So that number for 2008 is an amalgamation of all those moving parts.

Randy Cousins - BMO Capital Markets

But I was wondering if you could give us some kind of granularity. If nothing else, just how much of the $399 was just repricing?

Donald W. Seale

We can’t break it out that way for you. I will tell you that it was a significant part. Fuel was a significant part and then that mix effect, which was positive with respect to export, was a significant part of it as well.

Randy Cousins - BMO Capital Markets

And the other category that had a really substantial percentage increase was ag. And there is presumably no RCAF business in that chunk, but I wonder if you could give us some sense as to what your sense is on ag pricing or how you see your RPU trending for 2009 in the ag category?

Donald W. Seale

Again, in the agricultural world we had longer haul export traffic, longer haul Midwestern to Southeastern feeder traffic, which is RPU, we had the 27,000 carload increase in the agri fuels market that I mentioned, ethanol up 33% for the year, that’s higher RPU. Plus we had good pricing in the market.

Randy Cousins - BMO Capital Markets

Your slide on intermodal volumes, you gave us the fourth quarter numbers in terms of the change by intermodal category. Could you give us some sense of what those numbers were for the year? And what’s happening on the international side? Are you seeing more stuff coming in, is the growth on the East Coast or the Gulf or are you seeing more transcon business coming back at you?

Donald W. Seale

We are continuing to see our East Coast international business grow at a faster pace than our transcontinental, West Coast port of entry international freight. We closed out 2008 in the range of 54%, almost 55%, of our total international business coming through East Coast ports versus West. If we go back five years ago, we only had about 20% of our international business coming through the East Coast ports.

So all water service, with the larger vessels that a lot of the steam ship lines are deploying, the use of the Suez Canal, we are seeing all water service continue to grow, although the international volumes, in terms of imports and exports in the fourth quarter, were down. Exports were more favorable in the first three quarters. They both were less than favorable in the fourth quarter.

Randy Cousins - BMO Capital Markets

And for the year? Can you give us some sense of how these components worked out for the year as opposed to just the fourth quarter?

Donald W. Seale

I don’t have the percentages here in front of me but our international business was down a little more at the 15% in the fourth quarter because of something I just mentioned, is that the exports through the first three quarters was helping almost offset the decline in imports. And I think I showed you that chart in the third quarter.

In the fourth quarter we saw exports decline in addition to the imports. So for the first three quarters we had a more favorable trend on international than we did in the fourth quarter. I don’t have the percentage in my head.

Randy Cousins - BMO Capital Markets

What about for domestic truckload? Because again, that’s the one where that’s the truck to train conversion, the opportunity, did that slow in the fourth quarter or how did it track for the year?

Donald W. Seale

The domestic, the conversion was good in the first quarter. It really accelerated in quarters two and three when we saw diesel prices spike up. Even in the third quarter when diesel started to go down it was at a very high rate. I think the percentage was off slightly in the fourth quarter but that, we think, was just more a reflection of total volumes than a willingness of people to convert.

Randy Cousins - BMO Capital Markets

Of the guys you converted in the first three quarters of last year, how many have you retained, or have you any issues or concerns that a percentage of that new business, looking to 2009?

Charles W. Moorman

We have had a very high retention rate and I think that is evidenced by the fact that the conversion numbers have continued to be positive year-over-year. Highway truck prices have come down. It’s a tough market place out there in the trucking industry right now. But when we talk to our partners in the intermodal business all of them remain convinced that they want to stay on the railroad and continue to convert business to the railroad.


Your final question comes from John Larkin - Stifel Nicolaus.

John Larkin - Stifel Nicolaus

At the risk of asking a longer-term question here, I was wondering if you could remind us of the highlights of the Track 2012 program and what impact that will have over time, on your margins in particular, assuming that at some point we get back to a more normal economic environment?

Charles W. Moorman

As batting cleanup, that’s a great question to ask. The Track 2012 process is now our four-year vision for where we want to go. We started by setting some revenue goals. We’re rethinking them in light of the downturn. But then we set really the goals that will drive the company. OR goals, safety goals, and then goals around the four processes that are really the four levers of the railroad business.

The first, which we talk about all the time, is our service levels. We have some aggressive goals there. And then the other three are on the margin side. And they are asset utilization goals, work force productivity goals, and a goal to continue to reduce fuel consumption across the railroad as an indicator of better productivity for the fuel we use.

We have a significant number of initiatives underway. A steering committee which Deb Butler leads. I would tell that a lot of the project will, I think, be very meaningful in terms of reaching our OR goal, which we don’t announce, but as I said before we think that a sustainable operating ratio with a number that starts with 6 is obviously where we want to be.

And as we push ahead I would tell you that I think that you will start to see those incremental improvements probably start to kick in mid-year this year with some projects with a lot more accelerating in the next year. A lot of them are technology based and require substantial implementation time.

A couple that you have seen mentioned today are LEADER and our LARS process for locomotive allocation. UTCS will help on the productivity side. And we have a lot of really good initiatives out there.

So, longer term we want to take the operating ratio down from where it is today and we think the Track 2012 goals are what will enable us to do that.

John Larkin - Stifel Nicolaus

Probably moreso than any other North American railroad you have done a great job of laying out what I would call a strategic marketing plan that consists of projects like the trackage rights on the old Delaware and Hudson, the Patriot Corridor, the Heartland Corridor, the Crescent Corridor, the Meridian Speedway, now the Titusville project, which really extends the reach of the railroad, allows you to improve your service, grab additional market share, etc. Just when I think you have exhausted all of those possibilities, yesterday you reported another one.

Are we still in the early stages of this longer-term strategic marketing effort? Are there other projects that are on the drawing board that we could see revealed over the coming years, or have we pretty much exhausted most of the opportunities here that you see?

Charles W. Moorman

We’re not exhausted quite yet. We have some more ideas and if we can bring them to fruition we will be talking about them, hopefully over the course of the next year or two. We think there are still some places to go, which as you said, extend the reach of our franchise and give us a competitive advantage through better service and better routes.

But I want to say, we have a lot that we have announced already that we have still got work to do. We are still finishing the Speedway. The Heartland work gets done 2010. Crescent is a working project and it will be a longer project although we are starting, as Don mentioned, to see incremental traffic gains just with the incremental work we have done so far.

So we think there are more good ideas out there and we are pursuing them but we’re also paying a lot of attention to getting the things finished that we’ve already announced.

Thank you everyone. It’s been a longer meeting than usual but hopefully we have given you some color for the year and we look forward to talking with you again.


This concludes today’s conference call.

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