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Norfolk Southern (NYSE:NSC)

Q3 2010 Earnings Call

October 27, 2010 4:30 pm ET

Executives

Donald Seale - Chief Marketing Officer and Executive Vice President

Charles Moorman - Executive Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Mark Manion - Chief Operating Officer and Executive Vice President

James Squires - Chief Financial Officer and Executive Vice President of Finance

Leanne Marilley - Director of Investor Relations

Analysts

William Greene - Morgan Stanley

Garrett Chase - Barclays Capital

Ken Hoexter - BofA Merrill Lynch

Thomas Wadewitz - JP Morgan Chase & Co

Scott Malat - Goldman Sachs Group Inc.

Robert Salmon

Anthony Gallo - Wells Fargo Securities, LLC

Christopher Ceraso - Crédit Suisse AG

Walter Spracklin - RBC Capital Markets Corporation

Jon Langenfeld - Robert W. Baird & Co. Incorporated

Donald Broughton - Avondale Partners, LLC

Edward Wolfe - Bear Stearns

Cherilyn Radbourne - TD Newcrest Capital Inc.

Jason Seidl - Dahlman Rose & Company, LLC

Scott Flower - Macquarie Research

Operator

Greetings, and welcome to the Norfolk Southern Corporation Third Quarter Earnings Call. [Operator Instructions] It is now my pleasure to introduce your host, Leanne Marilley, Norfolk's Southern Director of Investor Relations. Thank you. You may begin.

Leanne Marilley

Thank you, and good afternoon. Before we begin today's call, 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 nscorp.com in the Investors section. Additionally, mp3 downloads of today's call will be available on our website for your convenience.

As usual, transcript of the call also will be posted on our website. At the end of the prepared portion of today's call, we will conduct a question-and-answer session. At that time, if you choose to ask a question, an operator will instruct you how to do so from your telephone keypad.

Please be advised that any forward-looking statements made during the course of this presentation represent our best good faith judgment as to what may occur in the future. Statements that are forward-looking could be identified by the use of words 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 risks 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 at nscorp.com in the Investors section.

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

Charles Moorman

Thank you, Leanne, and good afternoon. It's my pleasure to welcome all of you to our third quarter 2010 earnings conference call. Several members of our senior management team join me. Don Seale, our Chief Marketing Officer; Mark Manion, Chief Operating Officer; and Jim Squires, Chief Financial Officer, all of whom you will hear from today.

During our second quarter call, I indicated that we were optimistic that the momentum we generated in the first half of the year would continue into the third quarter as we maintained our focus on strengthening the franchise. Today, I am very pleased to report that our momentum did remain strong, as Norfolk Southern delivered double-digit percentage increases in revenues, operating income and bottom line results. In doing so, we've produced our fifth consecutive quarter of sequential volume growth and our second consecutive quarter with a sub-70 operating ratio.

Net income and diluted earnings per share were both up 47% for the quarter as a 19% improvement in revenues more than offset a 14% increase in operating expenses.

This strong operating leverage resulted in an operating ratio of 69.6%, which represents a 320 basis point year-over-year improvement. We also achieved our lowest ever operating ratio of 71.4% for the first nine months. Volumes in the third quarter improved 15% year-over-year and 2% sequentially from the second quarter. We also posted 52-week highs in several commodity groups, and Don will provide more details in a moment.

Against this strengthening economic backdrop, we continue to improve productivity as we safely handled increasing traffic levels. As compared to the 15% volume increase, crew starts were up only 8% and total employment up a modest 2%.

While we have experienced significant traffic volume swings over the past two years, our systems continue to provide us with increased flexibly and service consistency with respect to our operating plan. The third quarter also marked another significant milestone for our Intermodal service. As last month, we opened the Heartland Corridor, which represents the shortest, most direct, double-stack intermodal route linking the Port of Hampton Roads to the Midwest.

Mark will review our operations with you in a few minutes, and then Jim will provide you with an overview of our financial results. But first, I'll turn it over to Don for a more in-depth look at our third quarter business.

Donald Seale

Thank you, Wick, and good afternoon, everyone. The third quarter marked our fifth consecutive quarter of revenue growth since the beginning of last year's deep recession. Volume growth across the board and higher revenue per unit combined to generate revenues of $2.5 billion for the quarter, up $393 million or 19% over the third quarter of last year.

Each of our business groups produced year-over-year gains for the quarter. Nearly 80% or $312 million of our total revenue gain was driven by higher shipments, while continued growth in revenue per unit contributed $81 million of the increase.

Looking at revenue per unit in more detail, on the next slide, we can see that all of our business groups had a higher RPU in the quarter, resulting in a total of $1,401 per unit, up $46 or 3% over last year. Negative mix within Coal, Chemicals, Agriculture and Intermodal dampened otherwise solid RPU gains across these business segments, which were driven by improved pricing and higher fuel-related revenue. For example, Intermodal's RPU growth in the quarter was negatively impacted by increased empty repositionings, which accounted for 16% of total Intermodal volume in third quarter 2010 compared to 11% last year.

This suppressed Intermodal RPU by $13 per unit. Coal RPU was effectively moderated by a combination of higher volumes of shorter-haul utility coal to our northern utilities, heavier domestic Met Coal shipments to the river and higher volumes of export Met Coal from Pennsylvania to the Port of Baltimore. Chemicals RPU was impacted by lower RPU shipment supply ash from Tennessee to Alabama and agricultural RPU was impacted by gains in short-haul grain markets in the Midwest as well as incremental gains in short-haul phosphate rock shipments.

With respect to managing yield, as we have stated in previous quarterly meetings, our ongoing objective is to produce pricing that exceeds the rate of rail cost inflation, and we remain confident of our ability to meet that objective.

Now transitioning to volume on Slide 4, our balanced portfolio of business continued to deliver growth as we reached 1.75 million units, up 15% over third quarter of 2009. As with revenue, this was our fifth quarter of sequential increases. Increased volumes were led by Intermodal, Coal and Metals, which offset a small decline in our Automotive business resulting from the redesign of the Ford vehicle network. As we've noted in prior quarters, this redesign will impact year-over-year comps through the end of this year.

During the quarter, our Chemicals and Intermodal groups achieved 52-week high loadings, and we continue to reinvest in our network, allowing us to efficiently handle increased business and provide even better service to our customers. We're also building upon our strong focus of developing new terminals, technology and route improvements to benefit all customers across our network.

During the quarter, we added speed and capacity enhancements with the completion of one of our biggest projects, the Heartland Corridor as Wick mentioned, which I will discuss in more detail later in my remarks.

Now let's turn to a review of our individual business group performances for the quarter. Starting with coal. Volume was up 15% in the quarter as shown on Slide 5, led by broad gains across the business in Domestic Met Coal, exported utility coal and the coal sector continues to recover and it produced its strongest volume since the fourth quarter of 2008, which I should note was a record year for coal over our network.

As depicted on Slide 6, metallurgical coal, coke and iron ore volumes were up 25,000 carloads in the quarter or 73% over last year. Growth was led by increased steel demand resulting from the improving domestic economy. U.S. steel production was up 29% in the first two months of the third quarter. At the end of the quarter, only seven blast furnaces were down, reflecting gradual recovery in the steel industry, and domestic Met stockpiles remained below target at many of our steel producers, which bodes well for demand ahead.

As shown on Slide 7, our export coal volume was up 5,000 carloads or 11% in the third quarter. Shorter haul export volume through the Port of Baltimore increased 94%, driven by Pennsylvania coals moving to the Asian market, which are no longer exporting coals, coking coals, due to strong internal demand. The increase in Baltimore traffic effectively offset a 14% decline in export coal to Lambert's Point, which was impacted by higher finished steel inventories in Europe.

Concluding with utility coal on the next slide, volume was up 21,000 carloads or 8%, the first year-over-year gain since fourth quarter 2008. Growth in our shorter haul northern utility network was up over twice as much as longer haul shipments to southern utilities. Coal burn increased during the summer due to well-above average temperatures in the east and improved economic activity.

As shown on this slide for August, it was reported by Energy Ventures Analysis that eastern stocks in total were only 2.7 million tons above normal. Currently, 20% of the utility plants in our network have informed us that they are now below targeting inventory levels.

Going into the shoulder months, which we're in now, lower seasonal temperatures and low natural gas prices will moderate coal burns and slow stockpile declines, but economic growth should raise electricity demand, which is up 9% in our service region. In this regard, our utility volume strengthened in September, up 16% for the month compared to overall third quarter growth of 8%, and we expect utility volumes to accelerate in the fourth quarter and through the coming year.

Now transitioning to Intermodal on Slide 9. Third quarter volume was up 122,000 units or 19% over last year. Domestic growth led the improvement for the quarter, up 30% due to continued success on highway conversions and increased transloading at Pacific Coast ports. Of our total domestic increase for the quarter, we estimate that 54% came from new local business east of the Mississippi with the remaining 46% from traditional interline business such as the Transcon market.

International volume increased by 11%, driven by higher imports and exports. Both in Domestic and International segments, revenue empty movements increased by 21% in the quarter as tight container capacity prompted repositioning for loads. And finally, our premium volume grew 23% in the quarter due to increased activity in the parcel and LTL markets.

Turning to the next slide, our ongoing corridor strategy has been a major factor in growth across our Intermodal network. Our Heartland Corridor officially opened for business on September 9, and we are already seeing the benefits of this project as we've shifted over 30% of our overall Norfolk volumes to the new route. We have begun stacking key lanes such as Chicago to North Carolina and Norfolk to Columbus. When we complete our Cincinnati to Columbus clearances and our Toledo yard improvements in the second quarter of 2011, we will ship another 10% of our Norfolk book to the Heartland route.

As shown on the next slide, we also have the Premier Route from the Port of New York to the Midwest through Pennsylvania, which as you might recall was the first major tunnel clearance project undertaken by Conrail. You will also note that business on this high-speed route was up 24% for the quarter and 20% for year-to-date.

And the recently announced tunnel clearances in New Jersey in conjunction with our PanAm Southern joint venture will provide for new NS double-stack service from the Port of New York to upstate New York and New England.

Progress on the Crescent Corridor continued in the quarter, with the recent groundbreaking for our newest terminal at Green Castle, Pennsylvania along with ongoing work and speed enhancements over the route itself.

Finally, as shown on Slide 14, the improved Meridian Speedway provide shippers with the most direct and fastest route between Southern California and points in the southeast including Atlanta, Charlotte and Birmingham. And our Chicago to Florida business continues to ramp up using our new Titusville terminal.

In sum, we remain very pleased with our progress and growth over our entire intermodal corridor network.

Now concluding with our Merchandise business on Slide 15. Volume in this broad set of carload markets reached 588,000 loads, up 11% over third quarter 2009. Metals & Construction led volume growth with a gain of 20%. Increased global and domestic steel production and growth from inter-mill business drove the gain in iron and steel volume.

Aggregates volume was up due to increased highway construction, paving projects and a greater seasonal push to ship before winter months. Project growth including scrubbers stone and frac sand shipments for natural gas drilling also contributed to gains in the quarter.

Chemicals volume increased 12%, led by gains in strong growth in our Petroleum business, which was up 19%. Improved chemical production increased demand for consumer goods and strong project growth drove the improvement in this commodity sector. Our Agricultural volumes were up 9% in the third quarter driven by growth in feed, fertilizer, soybeans and corn. These volumes benefited from growth to export markets along with increased volumes to keep processors in the Southeast. And fertilizer growth was driven by the continued ramp up of the phosphate and potash markets.

As shown on the next slide, paper and forest products volume was up 7% in the third quarter, driven by increased demand for kale and clay and wood pulp in the export market. In addition, lumber volume was up as a result of modest growth in the weak housing market.

And finally, automotive volume declined 1% in the quarter, due to the redesign of our Ford network. Without this year-over-year adjustment, which reduced volume in the quarter by 8,300 loads versus last year, automotive volume would have increased 10%.

We also expect new auto assembly plants now being completed by Volkswagen shown here and BMW shown on the next slide to add to our Auto business in the months ahead. These two plants combined will represent 230,000 new units of production and over 3,600 new jobs in their respective markets.

Volkswagen's outbound rail shipments are slated to begin late in the second quarter of next year. The plant will build a new midsize Sedan and have the capacity to build 150,000 vehicles annually. And BMW's plant expansion is now complete and will increase capacity from 150,000 vehicles to 200,000 units starting in early 2011 with over 50% of production exported out of the Port of Charleston.

Now let's turn to our outlook. As we move into the fourth quarter and beyond, we expect to see continued growth in our core business, which will be supplemented by project growth and our ongoing corridor strategy. We expect Chemicals will continue to expand as we marked a record high revenue level in the third quarter.

Our outlook for the agricultural market remains bright, and we expect the September 2010 through April 2011 grain export season to be very positive with double-digit growth going forward. Our Steel business, which includes export and domestic Met Coal, along with finished iron and steel volumes will continue to benefit from the slow but gradual recovery in global steel production.

Current dynamics in the trucking industry, including labor costs, higher labor costs, and tighter truckload capacity, along with improving economic conditions coupled with our developing Corridor strategy bode well for continued Intermodal conversion ahead. And as previously mentioned, projected increased electricity demand from economic growth, along with lower stockpiles, should positively impact Utility Coal's performance as well. We expect to see growth in all of our coal market segments in the fourth quarter and for the next year.

In summary, as shown in the final slide, we now have seen sequential volume recovery in each quarter since the third quarter of 2009. Third quarter volumes were 33,000 loads or 2% higher in the second quarter and 170,000 loads higher than the first quarter this year. Economic conditions, while still challenging with respect to housing and unemployment continue to show sequential improvement in industrial production and global trade.

Our third quarter volume growth of 15% reflects that positive trend along with strong project growth across our core markets. We expect this positive trend to continue through the fourth quarter and throughout 2011 as gradual economic recovery and targeted business development efforts converged.

Finally, we remain confident in our ability to provide safe, reliable and efficient service to our customers, which supports higher value pricing in the marketplace ahead. Thank you for your attention and I'll now turn the podium over to Mark for our operations report.

Mark Manion

Thank you, Don, and good afternoon, everyone. Starting with safety, Norfolk Southern's safety performance through the third quarter stands at 0.94 injuries per 200,000 employee hours worked, which is a 22-point reduction or 19% improvement for the same period in 2009.

For consecutive quarters during 2010, we have improved our safety performance, recording sequential improvement each quarter this year. We attribute this improvement to our ongoing safety training, which reinforces the importance of effective job briefings, teamwork and communication.

Turning to our operating performance, our road and yard crew starts increased 8.1% over the third quarter of 2009 as we modified our operating plan to efficiently handle the increasing volumes. Of course this is well below our carload unit increase of 15% and 14% for gross ton miles for the same period.

Turning to the next slide. Train and Engine employment increased by 501 or 4.8% in the third quarter as we continue to strategically hire to support traffic growth where we had led attrition decrease employee in counts in 2008 and 2009. As I've stated last quarter, all T&E employees have been returned from furlough status. To date, we have authorized the hiring of 1,550 conductor trainees, with the first of those trainees now starting to come off training program ready for placement.

Turning to our Composite Service performance on Slide 5. This measure is a composite of train performance, connection performance and operating plan adherence. We are responding well to the 15% increase in volumes as our service improved from the first to second quarters and again from the second to third quarter. We will continue to see improvements as we align resources to our operating plan in order to meet demand and drive further improvement going forward.

Finally, turning to our Productivity Scorecard. In light of carload unit volume being up 15% for the quarter, you'll note that we have been able to very effectively manage the operating plan. Substantially higher volumes have been handled with only an 8% increase in crew starts. For the quarter, total railroad employment was increased 3% over the same period of 2009. Gross ton miles per employee continued improvement in the third quarter while gross ton miles per gallon of diesel fuel stayed constant. Gross ton miles per train hour declined 1% and car hire days per carload increased 4% with a slight degradation in train speed and terminal dwell. Thank you and let me turn it over to Jim.

James Squires

Thank you, Mark, and good afternoon, everyone. I will now review our financial results for the third quarter. Let's start with our operating results. As Don described, railway operating revenues for the quarter reached $2.5 billion, up $393 million or 19% compared to the third quarter of last year.

Slide 3 shows our total operating expenses, which increased by $209 million or 14% for the quarter. Income from railway operations grew 33% to $746 million. The generous increase in revenues driven by higher volumes and revenue per unit was partly offset by increased operating expenses. The resulting operating ratio was 69.6%, only 50 basis points shy of our record third quarter operating ratio set in 2008.

Turning to our expenses, here are the major components of the $209 million net increase. Much like our second quarter results, compensation and benefits and fuel expenses accounted for over 70% of the variance. Slide 5 reflects the components of the 14% increase in compensation benefits. First, volume-related payroll increased $34 million including $18 million for train and engine employees. Second, medical benefits increased $20 million, largely related to higher agreement employee health and welfare premiums coupled with increased retiree medical costs. Third, incentive compensation was up $13 million, due primarily to stronger financial results. Pension expenses were $8 million higher and payroll taxes increased $7 million.

Finally, increased agreement wage rates and other compensation expenses were offset by lower stock-based compensation, which reflected last year's strong improvement in performance metrics.

As shown on Slide 6, fuel increased by $67 million or 35%. As displayed on Slide 7, nearly 2/3 of the increase in fuel expense was due to higher prices. Our average price per gallon of diesel fuel was $2.19, an 18% increase compared to the third quarter of 2009. Consumption was up 14%, one percentage point below the increase in unit volumes.

Slide 8 highlights the $41 million or 28% increase in materials and other expenses. Materials usage for equipment and road maintenance increased with higher volume levels. In addition, prior year results benefited from more favorable property tax accrual adjustments and more favorable personal injury claims development.

Purchased services and rents increased $25 million or 7%, reflecting increased equipment rents and other volume-related services.

Slide 10 displays our non-operating items. The majority of the net increase is due to a gain on the sale of land to the City of Virginia Beach and coal royalties, which reflect a favorable one-time settlement reached during this quarter. As illustrated on Slide 11, income before income taxes increased $233 million or 48%, principally due to higher operating income. Income taxes totaled $269 million and the effective rate was 37.7%. Income taxes last year were $178 million with an effective rate of 37%.

Turning to Slide 13. Third quarter net income was $445 million, an increase of $142 million compared to last year. And diluted earnings per share were $1.19, a $0.38 per share increase.

Slide 14 presents our year-to-date cash flows. Cash provided by operations increased over 50%, easily covering capital expenditures, share repurchases and dividends. Share repurchases in the third quarter were $323 million as we bought back 5.8 million shares. Cash and cash equivalents at the end of the quarter equaled $1.1 billion.

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

Charles Moorman

Thank you, Jim. As you've heard, our third quarter performance continues to showcase our balanced customer portfolio, superior service product and ability to generate operating cash flows to fund substantial core and strategic investments in our franchise.

From an investment perspective, our current estimates for 2010 capital spending is about $1.5 billion. While our 2011 capital plans have not been finalized, we do anticipate that our spending next year will be higher, driven by spending on positive train control, new locomotives, the conclusion of our implementation of SAP and reinvestment in our coal car fleet.

In addition, we're also looking at our ongoing equipment strategy as to the advantages of ownership rather than our current policy of leasing some of our core assets, particularly given current financing rates. At the same time, we are and will remain committed to returning value to our owners, through our industry-leading dividend yield and ongoing share repurchases.

Looking ahead, we expect that the economy will continue to expand albeit at the fairly low rates that we have seen over the past couple of quarters. Our strategy remains to continue to grow our business profitably through continuing focus on and investment in improving our service and strengthening our franchise. We are optimistic that we can continue to grow our traffic at a pace that exceeds the growth in gross domestic product, and that volume growth, combined with our focus on improving margins will drive superior shareholder returns.

Our third quarter results illustrate our ability to execute this strategy and I am confident that Norfolk Southern will build on this quarter's momentum to drive a superior product for our customers and superior financial results.

Thanks for your attention, and I'll now turn the program over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Jon Langenfeld with Robert W. Baird.

Jon Langenfeld - Robert W. Baird & Co. Incorporated

On the Intermodal side, can you talk a little bit about the pricing there? I understand the mix impact you described. But even adding that back, I think your revenue per unit will be up only 2%. Can you talk about that in light of the fact that volumes were so strong and your ability to take rate increases through the year?

Charles Moorman

John, we are seeing some improvement in truckload pricing in the marketplace. With respect to our third quarter traffic, as I mentioned in the comments, about 55%, 56% of our growth in our domestic sector came east of the Mississippi, which is generally shorter haul traffic. It's good business for us. But it generates an RPU that is a little less than Transcon or longer haul business. So that factors into the RPU, as well as the increase in revenue empty repositionings that I mentioned as well. So all in all, we're seeing a gradually improving marketplace for intermodal pricing, and we think that will continue based on what we see right now.

Jon Langenfeld - Robert W. Baird & Co. Incorporated

Any insight from the Ocean Liner in terms of the international import traffic as it relates to Intermodal in terms of what sort of signals they're giving you relative to year end and into the early part of year with the Chinese New Year being so early this time?

Charles Moorman

I think in general, the consensus is that we experienced a mini-peak, I would call it a mini-peak this year starting in August. That mini-peak is already beginning to top out and that's not too surprising. So I think that they are seeing slow and steady recovery of volumes, but it's uneven. And it's certainly not in a straight line in terms of volume growth.

Operator

The next question is from Bill Greene with Morgan Stanley.

William Greene - Morgan Stanley

Wick, I remember at the Investor that you had a year, year and a half ago, you talked about Norfolk Southern's approach to a downturn being sort of conservative and that you want to maintain resources to be prepared for when the volumes came back. And so, clearly we're seeing sort of the upside advantage, the incremental margins have come back from that perspective. But what I also thought would happen was that Norfolk Southern would see materially better incremental margins than competitors. And I don't think we're seeing that. So I'm wondering if there's a sort of lessons learned here or anyway to kind of think about how you might approach this differently going forward based on kind of similar performance to the peers at this point.

Charles Moorman

Well, I don't know. I won't comment so much about performance as compared to our peers. I think that we did have a policy, as we talked about, in terms of trying to think conservatively going into the downturn. The time that you were talking about that, the downturn really had not hit us in the way that it did. As we have recovered, I think that we have shown good operating leverage. We did keep an eye on being able to recover well. I think that we've seen some extraordinary volume shifts as we've talked about and you have seen good operating metrics and good operating leverage as Mark and Jim had described. So I think that all things considered, we come through in a way that we would have expected and the other thing that we have continued to do, as you know, is continue to invest in the property and that's a point we talk about a lot that we were going to continue with strengthening the franchise, investing in the technology. We think that's important to the future, and that's what we did, and that's what we continue to do.

William Greene - Morgan Stanley

If I think about what you're doing with Intermodal and the huge investments that you've made there, clearly it's going to deliver volume growth. But my sense is and I think that Don even mentioned this, that it's truckload conversion that will drive a lot of this from the highway. And I sort of think about that as kind of definitionally being more competitive business. So how we do we guarantee or how do we ensure that the returns there can be as good as some of the other businesses. I'm thinking for example like bulk.

Charles Moorman

I think you raised a good question. It is definitionally competitive. But we think that we are out there competing very effectively for that business. And we think that as that business develops, the combination of the volumes that we'll handle and volumes, and volumes always -- more volume improves margin as we spread network cost over larger and larger number of units, and the focus that a lot of our investment has in terms of making the Intermodal operation more and more efficient. In terms of technology and in terms of terminals, we feel confident that we're going to continue to develop business growth and volumes that are at margins that we're comfortable with and provide good return for our shareholders. And I think if you kind of think about it from a very high level, the operating ratio that we are posting with the large volume increases we're seeing in the domestic Intermodal are an illustration that we're able to do that.

Operator

The next question is from Tom Wadewitz with JPMorgan.

Thomas Wadewitz - JP Morgan Chase & Co

Wanted to ask a bit more on coal. You seem to have a pretty optimistic outlook. I think across the board and all the major drivers of your coal volume, how does some of the potential production issues in greater regulatory pushback on Central Appalachian coal, how does that affect your network? Is that a risk or is it as simple as if you don't source it from Central App, you'll source it from somewhere else? I guess it's really a second question, but also how do we think about natural gas sensitivity? It just seems like natural gas may stay at low levels, which eventually would be a risk for coal. So those two questions on coal outlook.

Charles Moorman

Tom, we're certainly are seeing more diversity with respect to coal sourcing taking place although I would point out that Central App production was up this year about 4%, even with what's going on in terms of further environmental restrictions on mining. But we are well positioned to source coal from Central App, Northern App, Illinois-based and RPRB (sic [(NYSEARCA:PRB) Powder River Basin], and we're participating in all of those flows. And we feel comfortable that demand is going to be there and sourcing of the coal is going to be there to match up with it. With respect to natural gas, we still see gas at low cost levels. But quarter-over-quarter, it was up over about 38%, 39% compared to last year. And coming through this summer, we saw very, very little diversion of coal burn to gas.

It took all of the generation capacity there. I think that based on continued economic recovery and the demand for natural gas right now, it's a little bit below $4. But I think, depending upon what the winter looks like, we'll see that come back up over $4, and everything that we're being told by our utilities is for us to expect heavy demand for utility coal restocking for the stockpile replenishment, as well as ongoing generation demand.

Thomas Wadewitz - JP Morgan Chase & Co

Is there potentially a lag impact from the low natural gas where you have minimum commitments in your contracts and the miners do as well. And when you start to roll over those and have lower minimums or the utilities negotiate lower minimums, that you would see kind of a lagged impact if you do have lower natural gas or you think you've already kind of seen the switching that's likely to take place, given current gas prices?

James Squires

I think what we're seeing is the lag that we've already seen.

Operator

.

The next question is from Walter Spracklin with RBC Capital Markets.

Walter Spracklin - RBC Capital Markets Corporation

My first question, I guess, is on the pricing. I know it's not something you like to give color on or guidance on. But I guess perhaps you could give us a sense of how your renewals were doing in the quarter? And perhaps what percentage of your book next year is locked in currently?

Mark Manion

We have, Walter, well over 90% of the business obviously locked in for this year, and we're right at 60% locked in for 2011. With respect to our ongoing renewals, they're within our target of meeting the overall objective that we have for pricing and yield.

Walter Spracklin - RBC Capital Markets Corporation

I guess that's your inflation plus kind of target.

Mark Manion

Correct.

Walter Spracklin - RBC Capital Markets Corporation

My second question is essentially on your capital program. I'm sort of trying to get an order of magnitude here. There's two components that I just like you to address. The first is the condition of your coal fleet, just looking at that and it's condition. What sense of an increase are you seeing in renewing that coal fleet? And then the second one, the order of magnitude of that switch that you mentioned from a leasing policy to an ownership policy, just so we can get our head around some of the financial impact of that shift in policy?

Charles Moorman

Well, let me first of all kind of give you, again, the caveat that we really haven't made any hard and fast decisions on capital budget to date. But to give you some idea of where we are, and we have discussed this before in a number of forums, we have a fairly sizable coal fleet in excess of 20,000 cars that we own, and we think that advantageous for us. In fact, the demands of our business around export and some of our other business really make it very desirable for us to own our own fleet. And the majority of that the fleet over the next six, seven, eight years will be reaching the end of its useful life. We've already renewed an excess of 3,000 of those cars. We'll have a program that begins next year that -- order of magnitude is probably going to average somewhere between 1,000 and 2,000 cars, maybe a little higher than some of the out years.

Walter Spracklin - RBC Capital Markets Corporation

That's on a per year basis, the 1,000 to 2,000?

Charles Moorman

On a per year basis. As to your other question, we're going to look at a fairly substantial portion of our assets that -- we currently have it under lease. We'll look at when those leases expire. We'll look to determine whether or not we think that those are assets that, because our assets are long-lived, that if we buy them today, we're going to be using them for the foreseeable future. We own a lot of equipment. So it is conceivable that we may be looking at assets that cost even up to a few hundred million dollars. But we're going to do this. This is something we will take a look at. We'll look at financing. We'll think about all the iterations. We will not do anything that we don't have a very clear view is going to provide positive value for us and our owners.

Operator

.

The next question is from Scott Flower with Macquarie Securities.

Scott Flower - Macquarie Research

Don, you were helpful on intermodal. What was the overall drag on your revenue per unit per mix in terms of the aggregate for the book of business?

Donald Seale

Scott, we do not have that for distribution on the call.

Scott Flower - Macquarie Research

And then just one clarification. On the $13 that you did mention for intermodal, is that just the end piece, or is that overall mix?

Donald Seale

Now that's for the empty repositioning.

Scott Flower - Macquarie Research

So that would not include the shorter-haul impact of the Eastern local business?

Donald Seale

No.

Scott Flower - Macquarie Research

So that's over and above the $13?

Donald Seale

Correct. $13 is just related to empty revenue repositions.

Scott Flower - Macquarie Research

I'm just curious, for Mark. On the thousand or so headcount that you authorized in terms of hiring and training, how many of those are currently on the property?

Mark Manion

We have really just started to bring in our newly trained conductors. I've got about 60 that are on the ground, on the job, and we will add another 300 by the end of the year. And then we'll continue with the pipeline we've got to build up. We will continue a pretty hefty roll out of conductors in the next year.

Scott Flower - Macquarie Research

But are the 300 folks that I'm assuming are on training, will be on the ground by end of year, are they already in the headcount numbers or they just actually started and they're just going into training?

Mark Manion

The 500 I was speaking of are in training now. And of those, 300 will be actively on the ground working by the end of the year. Total of about 360 by the end of the year.

Scott Flower - Macquarie Research

I'm just curious, were the 500 actually in the third quarter headcount numbers or is that going to show up more in fourth quarter?

Mark Manion

That is a third quarter count.

Scott Flower - Macquarie Research

And then the other quick question, just any color you can give. Any further update you can give us on the deployment of Movement Planner across the network?

Mark Manion

Yes. We have got four divisions so far underway with Movement Planner and our schedule calls to add another four divisions during 2011.

Operator

The next question is from Ken Hoexter with Bank of America.

Ken Hoexter - BofA Merrill Lynch

Maybe just talk a bit about the potential cost savings from the new corridor that you've seen since you've launched Heartland in terms of cutting down maybe mileage or your ability to double stack? And maybe just talk about the cost side of that equation.

Charles Moorman

We don't give out the specific cost figures on any of that. But we predicated the project on the fact that we were going to be able to move a significant amount of traffic, particularly over the long term on this more direct route, instead of sending it around a couple of far more circuitous paths. Mark, we've put a couple of extra turnings over there already, I believe? What were the numbers?

Mark Manion

We have. We've added two trains over there. And more importantly, we are filling out the trains that we've got, double stacking them.

Charles Moorman

So we are seeing the benefits of the quarter being opened up now. And we expect this business growth, that those benefits will become significantly higher.

Ken Hoexter - BofA Merrill Lynch

So when you mentioned earlier, it was what, you'd shifted 30% of -- you just threw out some numbers in the intro, 30% you were moving, 20% more. I just want to understand what you were kind of providing then. Is that of the total intermodal or is that within that region?

Donald Seale

Ken, in the quarter, there's about 60% of the business that currently moves to and from Hampton Roads and some of the other corridors that feed in to the Heartland Corridor. That will be converted. And we have ramped up 30% of that 60% conversion.

Charles Moorman

Ken, to give you the color, we were running one single stack intermodal train each way through there daily. We were running a couple around that were double-stacked. And that's the traffic that we will, first of all, now be able to load up the train that we were running, and then ship the other traffic. As Don mentioned, we've shifted a good amount when we finished the clearance project to Cincinnati for corn, I guess we'll ship more.

Ken Hoexter - BofA Merrill Lynch

Don, when you were talking, I guess, in one of the answers before going through the utility coal and kind of your outlook there, you kind of left off on the export side. And it looked like we've seen that kind of slowing trend on your slide earlier. You talked about Europe having high inventories. Is there an outlook that continues that trend on softening over the next few quarters on the export side, or are you as confident there as you are maybe on the utility side?

Donald Seale

Well, we remain positive on export, Ken. As I mentioned, our export traffic over the Port of Baltimore is up significantly. We saw some tough comps at Lambert's Point, and the business did soften a little bit. In the third quarter, I will tell you that based on what we're seeing in the fourth quarter in terms of bookings and the look ahead, we see that as a pause as opposed to a change in market direction.

Ken Hoexter - BofA Merrill Lynch

On the empties. I guess now that we've seen a bit of a slowdown on intermodal side, is that the empty repositioning lightening up or is that something you're seeing continuing to the fourth quarter?

Charles Moorman

So far in October, we see that continuing. I would suspect that it would start to mitigate somewhat if container capacity, overall capacity, improves.

Operator

.

Your next question is from Gary Chase with Barclays Capital.

Garrett Chase - Barclays Capital

Just wanted to see if I could get a little bit more clarity on some of the answers to what you were just discussing there with Ken. Is there a way for you to give us a sense of how much traffic in the network is presently double-stacked? Or how much was, say, before you opened the Heartland Corridor, and how much that's changing?

Donald Seale

Well, we were running stacks, so we could clarify that. We were running stacks but we were running them up over Harrisburg back over to Columbus and towards Chicago, all over from Norfolk to Knoxville and back up. So the available business that we will be converting, approximately a third of that has already been converted. Another 10% will be converted after we finish the Cincinnati clearances that we mentioned. And then, of course we'll have market growth with that, on top of that shift.

James Squires

To amplify that a little bit more, if you look at our overall intermodal network, which we think is a great network and we -- premier service in a number of significant quarters, I believe I'm correct in saying this was the last one that wasn't cleared for stack. So the vast majority of our traffic that we can stack, we're stacking in all of those corridors.

Charles Moorman

It's just a complete network after we've finished Cincinnati. And the Bergen tunnel in New Jersey opened up the northern route coming out of the shared asset area.

Garrett Chase - Barclays Capital

Is there a way to think about how much mileage you might be saving? Is there a statistic you can give us to give us some flavor for just how circuitous those alternate routings were?

James Squires

250 miles savings from the Port of Hampton Roads, Port of Virginia to the Ohio Valley, it looks like Columbus or so.

Donald Seale

Which is a full day's transit.

Garrett Chase - Barclays Capital

Don, you mentioned the coal inventories, and I'm wondering if there's any different flavor between the Northern and Southern utilities? And when you think about what's changing at the margin, whether we would expect that ramp in utility volume to be more northern- or southern-focused?

Donald Seale

We will continue to see the northern utility coal move. We are seeing increased demand through the South. And I think that, that will continue to trend up. I had mentioned that 20%, which is essentially 20 utility plants in our network of 100 utility plants are now telling us they're below their targeted inventory levels. And we'll tell you that a good portion of those 20 are not in the northern utility region.

Operator

.

The next question is from Jason Seidl with Dahlman Rose.

Jason Seidl - Dahlman Rose & Company, LLC

Don, can you go over some of the mix shift that you saw in the carloads and how it's going to impact 4Q, so we can start thinking about revenue per unit for 4Q? Are we going to see them all sort of continue like you saw in 3Q or some are going to update?

Donald Seale

In terms of the description that we gave here on third quarter, certainly the coal RPU will continue to see the mix effects that I described. Although we will continue to see a little bit more Southern utility coal as I've just mentioned, which will help mitigate some of that. With respect to the carloads business, we're going to continue to see in the fourth quarter some of the dynamics in the grain market that I mentioned. The chemical market with the fly ash will actually see a reduction in fly ash, so it's some improvement in chemical RPU from the fourth quarter. And everything else, in terms of Metals & Construction should be fairly constant for the fourth quarter.

Jason Seidl - Dahlman Rose & Company, LLC

For the second question, did you guys break out your favorable one-time settlement in the coal royalties? And if you didn't, could you please tell us what it was?

James Squires

This is Jim. As I mentioned, the majority of the increase in other income net was first the gain on the land sell to [indiscernible]. And then the settlement portion of the coal royalties increase was $13 million.

Jason Seidl - Dahlman Rose & Company, LLC

It was $13 million?

James Squires

Adding to the $48 million combined and excluding from the $81 million, that $48 million brings you down to $33 million in other income net.

Operator

.

The next question is from Scott Malat with Goldman Sachs.

Scott Malat - Goldman Sachs Group Inc.

I know it's a bit lumpy, but how do we think about that line? Is the run rate kind of $15 million from here, or should we think of it differently?

James Squires

Looking back at an average percent uninformative [ph] (1:07:39) due to the volatility of the income net. But this quarter, it was fairly [indiscernible] (1:07:46) recurring item other income net were about. And we think that's a [indiscernible] (1:07:52) for other income net going forward.

Scott Malat - Goldman Sachs Group Inc.

There's been a small business though. I think it applies to you also though in September, they made a provision for accelerated depreciation of assets. I think they can depreciate 50% of CapEx incurred in placed in service in 2010. I'm wondering if you get a benefit on that?

James Squires

Yes. And you saw a large increase in deferred taxes. And the benefit of that tax provision three quarters. So that explains the increase in deferred taxes and then you'll see continuing benefits out of the fourth quarter.

Scott Malat - Goldman Sachs Group Inc.

So it's the same kind of run rate from there?

James Squires

But bear in mind that the third quarter reflects three quarters' worth of bonus depreciation and its impact on deferred taxes. So in the fourth quarter you get one quarter's worth.

Operator

.

The next question is from Ed Wolfe with Wolfe Trahan.

Edward Wolfe - Bear Stearns

Just back to the yields again. The mix adjusted yields are just difficult to understand how much they've come down relative to last quarter. Other than what you said in the various mix within the different segments, is there anything else going on here? Is there a large customer who repriced the wrong direction or anything like that?

Charles Moorman

Ed, no. There's no specific effect like that.

Edward Wolfe - Bear Stearns

Is there any way to break out what the impact from mix was in fuel, relative to rate?

Mark Manion

That's something that we're not providing in this discussion, because frankly, I think that everyone understands our position with respect to discussing price in the marketplace.

Charles Moorman

Let me amplify that. We have said repeatedly, Don has said, and we obviously believe this, that we are very confident that over -- currently and over a sustained period time, we're going to be able to maintain pricing above the levels of rail inflation, and we have metrics that we look at and, as I say, it gives us a confidence that we are doing that and will continue to do that. But I want to emphasize that we do operate in what we feel is a very complex competitive marketplace. And we do not think it is to our advantage to enter into any kind of detailed discussion about price. And that's why we say what we say and don't say what we don't say.

Edward Wolfe - Bear Stearns

Mark, can you talk a little bit about the conductors? What's the attrition rate in 2011 if you didn't hire anybody?

Mark Manion

Our attrition generally runs about 8%, about 1,000 people. So as I've said, in our T&E ranks, we've authorized hiring 1,550 people this year, and we're up about 500 as I said year-over-year so far. And I would think next year, we will be at least 1,500, probably more like authorizing 1,800 or even above that come next year. And that's just in the transportation side.

Edward Wolfe - Bear Stearns

And then Don, just a little bit more on the coal expectations. I think you said on the export side, there's been a pickup in fourth quarter that gives you confidence the low-end third quarter was just below. Is that both on the steam and the met export side, or is it one way heavier than the other?

Donald Seale

The vast majority of our exporters, Metallurgical Coal, Virginal [ph] (1:11:59) Steam.

Edward Wolfe - Bear Stearns

So that pickup is on the met side export?

Donald Seale

Correct.

Edward Wolfe - Bear Stearns

In the U.S., what's your view of met on very tough comps for next year? How do you think about that?

Mark Manion

Well, as I mentioned in the comments, and you're seeing hard numbers up dramatically in the third quarter in terms of domestic met volume. We're being told that stocks of domestic Met Coal for steel production are still below target levels. Substantially below target levels. So we're planning on continued growth in that segment.

Edward Wolfe - Bear Stearns

One of your competitors reduced their PTC capital spending. Are you doing any of that? Is that in the forecast rate of this year or next?

Charles Moorman

Haven't really seen too much about what anyone else has said. Our PTC spending next year, we're not planning on reducing it in any way. We continue to plan and move forward to follow the legislation's mandate and have the system operation where we need it to by the end of 2015.

Edward Wolfe - Bear Stearns

What are you planning to spend in 2010?

Charles Moorman

Order of magnitude this year, it is under $100 million. It will be more than that next year.

Mark Manion

Next year is in the range of $120 million.

Operator

.

The next question is from Chris Ceraso with Credit Suisse Group.

Christopher Ceraso - Crédit Suisse AG

A couple of questions on incremental margin. First, if I think about the business overall, this year you've been running on a year-over-year basis in the, call it 50% range give or take. As you get into next year and you're starting to hire people and you're starting to add equipment, where does that moderate to? Is something in the 30% range more normal for the business? How do you think about that?

Charles Moorman

Chris, I think there's still some room to run on incremental margin, especially this year. Getting into next year, it becomes more challenging. But we think that certainly, lower operating ratios, now that being one key to group the incremental margin, are also within reach. But it is fair to say, we think, that it will become more challenging next year to produce further improvements in incremental margin.

Christopher Ceraso - Crédit Suisse AG

I mean you'll still earn some incremental margin on revenue growth, right? It just won't be as high?

Charles Moorman

Right. When I say further improvements, I mean in comparison to the incremental margin we've seen this year.

Christopher Ceraso - Crédit Suisse AG

And then maybe you can help me with kind of the marginal economics of the intermodal business, particularly as you go from single- to double-stack. What's the marginal benefit of adding a second box on top? Is that a 90% profit on that, or what are the economics of the extra box?

Charles Moorman

Well, I don't know that I have the exact numbers in front of me. But I think it's fair to say that it's significant just in terms of -- it's that many more boxes per -- you're leveraging your train starts, you're leveraging your network costs. You still have cost around lifts. There is some incremental fuel cost. So I'm not sure I'd be comfortable with 90%. It depends also on type of business as to whether there's dray involved and who's paying for the dray. But it's certainly a significantly driver of efficiency to be able to stack.

Operator

.

The next question is from Cherilyn Radbourne with TD Newcrest.

Cherilyn Radbourne - TD Newcrest Capital Inc.

Nobody has asked you about the regulatory landscape, so maybe I'll just ask you for a bit of an update there. And any comments you have on the risk to the FTD? You may start to direct this attention to rail-to-rail competition and access issues, et cetera?

Charles Moorman

A lot of folks talk about this all the time, so I'll be brief. While never say never, it certainly looks like this congress will adjourn without anything having happened on the legislative front in terms of rail regulation. We'll have to see what the new congress brings. But it's an issue that's been out there for 20 years, so we'll obviously be continuing to talk about it. As far as the FTD goes, that's an interesting question. But the FTD has, as its first mandate, to ensure that railroads earn an adequate return on capital. And I think we're confident that the FTD notes that mandate and will be guided by it in the decisions that they make in the future. But we'll obviously continue to watch that very closely as well.

Operator

.

Next question is from Jeff Kauffman with Sterne Agee.

Unidentified Analyst

It's actually [ph] (1:18:01) in for Jeff Kauffman. We had a quick question on -- wanted to get a better sense of why train speeds were down while terminal dwell is up? Kind of trying to understand if this is something new and unique, or what's going on?

Charles Moorman

Train speeds are down. The good news is that the railroad is operating well, good fluidity in the terminals, good connection performance, which of course is very important to our customers. And as we paddle hard in order to get the resource level up to where these nice volumes have been, that will improve our train speed. These conductor forces that are now coming on will give us a lot of help in that area, and we're also taking delivery of more locomotives through the fourth quarter and actually first quarter as well. So those resources will give us a nice boost as we get our train speeds back up.

Unidentified Analyst

And then on the terminal dwell side?

Charles Moorman

The terminal dwell has been really the same story, to the extent that we have instances where we don't have crews available to pull the train as timely as we would like. That of course increases our dwell time. And over these next several months, as our crews come available, we'll see not only the velocity improve but we'll see that dwell time drop back to the historically low levels that we've had.

Unidentified Analyst

And you think that'll happen in the next quarter, or in two quarters?

Charles Moorman

That is something that we will see as we go on through the quarter. We'll see improvement in November and then even more so in December as we have more resources available.

Operator

.

The next question is from Justin Yagerman with Deutsche Bank.

Robert Salmon

It's Rob Salmon on for Justin. You had spoken a little bit earlier about Movement Planners. The Movement Planner software that you guys are implementing. Could you give us a sense what sort of productivities and improvements you're seeing on the four divisions where it's currently running? Whether you're talking about kind of gross ton miles per train hour or gross ton miles per gallon? What that technology is helping you guys do?

Charles Moorman

Keep in mind it's pretty early in the game, and we like what we see so far. With this relatively modest deployment so far, we are seeing in the neighborhood of a two- to four-mile an hour improvement, which in railroad parlance is a pretty big deal that equates to about a 10% to 20% velocity improvement. So we'll keep working on that. We'll keep rolling that out. And the early indications are that is the nature of the improvement.

Robert Salmon

I didn't see a fuel surcharge revenue in the slides. Could you guys provide us with what that was in the third quarter?

Charles Moorman

Sure. The fuel surcharge revenue in the third quarter of this year was $179 million versus $99 million in the third quarter of 2009 for a favorable delta of $80 million.

Robert Salmon

Finally, on the sideline capacity. Could you give us a sense what sort of locomotives you guys currently have parked that could be deployed that's also railcars?

Charles Moorman

We do not have any locomotives in storage. We've pulled them into action and we've leased some locomotive power. But more importantly, we are taking delivery of some new power. As I mentioned this fourth quarter, we're going to get 42 locomotives, and then another 50 as we go into 2011 during the first half.

Robert Salmon

And on the railcar side?

Charles Moorman

On the railcar side, we have still got some storage, but it has dwindled down. Last I looked it was in the 6,000 to 7,000 range.

Operator

.

Our next question is from Anthony Gallo with Wells Fargo.

Anthony Gallo - Wells Fargo Securities, LLC

I guess it's also on network capacity. If I have my numbers right, it looks like your 2010 carloads will finish up somewhere between 10% and 12% below 2007 levels that's caused the pre-recession peak. But it sounds like you've got resource needs now. So I'm just trying to reconcile, carloads aren't where they used to be, but assets are. I'm just trying to reconcile that.

Charles Moorman

In light of the volume that came on rapidly, that created the resource needs. Like I said, that should rectify itself as we go through the fourth quarter and on into the new year. So that's good. And then that will help us get our velocity back up to where it has historically been. And as you know, that in itself, that creates room on the railroad. There's a lot of benefit to that. We both get the benefit of turning the assets more quickly and freeze up capacity on the railroad.

Mark Manion

If you look at where we are compared to those volumes, we're certainly not seeing infrastructure issues in terms of capacity. Locomotives, we had retired some, so the number has gone down. But as Mark said, we've got a few leads right now because velocity issues. Where we are still substantially below 2007, though, is on the train and engine service headcount. And as Mark has outlined, we've got plans to bring that back up. But if you look at the relative numbers between 2007, 2008 train and engine services and our current numbers in service today, we're down substantially, and that's the issue we're addressing.

Anthony Gallo - Wells Fargo Securities, LLC

Does mix play a role? Is there just one generally less train unit business now than there was in '07?

Charles Moorman

No, there's no less. Mix does play something of a role in terms of how we dispatch crew and locomotives. And so that -- we're seeing, as Don pointed out, we're really seeing some very heavy unit train business right now because in addition to the coal, we're handing a lot more export grain than we were a couple years ago, and some additional grain for domestic users as well, as we've implemented our 75-car unit grain train network. So if anything, we're seeing more unit trains rather than fewer these days.

Operator

.

The last question is from Donald Broughton with Avondale Partners.

Donald Broughton - Avondale Partners, LLC

The planned expansion for BMW and the Volkswagen plant, only you serve those plants or do both you and CSX serve those places? In other words, are you going to be able to capture all the incremental volume, or is there some competition for that?

Charles Moorman

Don, we serve the BMW plant exclusively, and the Volkswagen plant will be jointly served. And we're confident that we'll get our share of the business.

Donald Broughton - Avondale Partners, LLC

When is the Volkswagen plant due to open?

Donald Seale

It'll be ramping up production in the second quarter of 2011.

Operator

There are no further questions in queue. I'd like to turn the call back to management for closing remarks.

Charles Moorman

Thank you very much for being with us today. Thanks for the great questions, and we look forward to talking with all of you throughout the quarter, and with you being with us for our next earnings call in January. Thanks.

Operator

.

This concludes today's teleconference. You may disconnect your lines. Thank you for your participation.

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