Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Norfolk Southern (NYSE:NSC)

Q1 2012 Earnings Call

April 24, 2012 4:30 pm ET

Executives

Michael Hostutler -

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

Donald W. Seale - Chief Marketing Officer and Executive Vice President

Mark D. Manion - Chief Operating Officer and Executive Vice President

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

Analysts

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Christian Wetherbee - Citigroup Inc, Research Division

Justin B. Yagerman - Deutsche Bank AG, Research Division

Edward M. Wolfe - Wolfe Trahan & Co.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

Brandon R. Oglenski - Barclays Capital, Research Division

Ken Hoexter - BofA Merrill Lynch, Research Division

William J. Greene - Morgan Stanley, Research Division

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Operator

Greetings, and welcome to the Norfolk Southern Corporation First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Michael Hostutler from Norfolk Southern, Director of Investor Relations. Thank you, you may now begin.

Michael Hostutler

Thank you, and good afternoon. Before we begin today's call, I would like to mention a few items. First, the slides of the presenters are available on our website at nscorp.com in the Investors section. Additionally, transcripts and MP3 downloads of today's call will be posted on our website for your convenience.

Please be advised that any forward-looking statements made during the course of the call represent our best good faith judgment as to what may occur in the future. Statements that are forward looking can be identified by the use of words such as 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, that is 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 Wick Moorman

Thank you, Michael, and good afternoon, everyone. It's my pleasure to welcome you to our first quarter 2012 earnings conference call. With me today are several members of our senior team, including Don Seale, our Chief Marketing Officer; Mark Manion, our Chief Operating Officer; and Jim Squires, our Chief Financial Officer, all of whom you will hear from this afternoon.

I am very pleased to report that Norfolk Southern had an excellent first quarter, setting records in most financial and operating metrics. Our results included across the board, all-time first quarter highs for revenues, income from railway operations, net income and earnings per share. And the operating ratio of 73.3% equaled our best-ever first quarter performance.

Beginning with the top line, revenues for the first quarter rose 6% to $2.8 billion. Volumes were up 1%, notwithstanding a 12% decline in coal traffic. The overall volume increase was led by double-digit growth in automotive, as well as metals and construction. Revenue per unit rose by an average of 5%.

On the expense side, a strong focus on efficiency, combined with mild weather, resulted in record income from railway operations of $745 million, which then translated into net income of $410 million and earnings per share of $1.23. These results enable the first quarter dividend increase of 9%, a first quarter record operating cash flow exceeding $1 billion and first quarter share repurchases of $400 million.

Stepping back a little, the real story for the quarter was how the diversity of our franchise, along with a network that is performing at a high service level, helped us to deliver these excellent results.

As always, Don will take you through all of the moving parts of our business. Mark will give you a look at our key operating metrics and the impact of our increased velocity and reduced terminal dwell times. And Jim will walk you through all of the numbers.

I'll return with some closing remarks before we take questions. But now, let me go ahead and turn it over to Don.

Donald W. Seale

Thank you, Wick, and good afternoon, everyone. During the first quarter, our broad portfolio of markets generated record first quarter revenue of $2.8 billion, up $169 million or 6% versus first quarter 2011, despite a weaker coal market. This included an all-time revenue record within Merchandise of $1.5 billion, up $177 million or 13% over last year. Intermodal revenues set a first quarter record of $527 million, up $42 million or 9% over 2011, while Coal revenue for the quarter was down 6%, primarily due to volume declines.

Overall yield increased 5% and volume grew by 1% with 5% gains in both intermodal and merchandise, which more than offset a 12% decline in Coal shipments.

Of the $169 million in revenue growth during the quarter, more than 80% came as a result of higher revenue per unit, including pricing gains and fuel surcharge revenue. Higher volume accounted for the remainder of the revenue increase.

Breaking out yield, the next slide shows we achieved an all-time high revenue per unit of $1,611 up $80 per unit or 5% versus first quarter last year, with increases in all business groups. Merchandise set an all-time record of $2,549 per unit, up $185 or 8% versus last year. Three of the business units within merchandise, metals and construction, paper and chemicals also posted all-time highs. Revenue per unit within Coal was up $125 or 6% over first quarter 2011, and intermodal was up $22 or 3% in the quarter.

During the quarter, we obtained pricing in excess of rail inflation to support balanced investment across our network and appropriate returns for our investors.

Now turning to volume for the quarter. Despite the challenges in Coal due primarily to weak electricity demand, the strength of our intermodal and merchandise networks drove volume up by 20,000 loads or 1% for the quarter. Intermodal gains came mainly from the domestic segment, up 13%, which led to a 5% increase in total intermodal volume. Merchandise volume also grew by 5% for the quarter on the strength of automotive and steel, as well as higher volumes associated with shale oil and gas drilling.

Now drilling down into our major business sectors, starting with Coal. Coal revenue for the quarter of $766 million was down $50 million or 6% due primarily to a 12% decline in volume. Notably, the majority of our coal traffic moves in unit train service. And in that regard, there was approximately a one-to-one relationship in terms of reduced crew starts and locomotives compared to the volume decline. An improvement in revenue per unit of 6% helped partially offset the effect of weaker volumes.

As depicted on the next slide, utility coal loads were down 17% during the quarter. This was the warmest first quarter on record according to NOAA, with records dating as far back as 1895. You'll note that heating degree days within the NS service region were down 27% for the quarter as compared to 2011, and also down 26% compared to the normal range. March, in particular, was a very warm month, officially the warmest on record in the contiguous U.S. And heating degree days during March alone were down by 47% versus last year.

Based on recent generation trends within our service region, we estimate that weak electricity demand accounted for roughly 75% of the volume decline in our utility market, while competition due to natural gas had less of an impact.

Coal burn at Eastern utilities was down over 28% through the first 2 months of the year, primarily as a result of this very mild weather pattern and competition from 10-year lows in natural gas prices. Within our utility network, volumes to our longer haul Southern utility plants were down 24%, while loads to Northern utilities were down 11%. Higher demand in our domestic metallurgical market, which was up 19% for the quarter, helped to partially offset the decline in utility coal. Domestic metallurgical volumes were up in response to increased domestic steel production, which was up 7% in the quarter.

Volume within our export market was down 10% due to the return of Australian supply and weaker global demand for steel. World steel production, excluding North America, was down 3% for the first 2 months of the quarter, driven primarily by weakness in the European market and weaker Chinese production in January.

On the plus side, we handled over 600,000 tons of new export steam coal business during the first quarter. Low domestic demand for steam coal and excess inventories led producers to opt to ship thermal coal to overseas markets. And finally, we handled over 18,000 loads of industrial coal in the quarter, which was up 3% due to new business gains.

Concluding my comments on Coal, Slide 9 shows the relative differences and length of haul among our various coal market segments. Export met coal moves on average, for example, approximately 480 miles, while domestic met moves about 40% fewer miles. Conversely, in the utility segment, coal to our Southern utilities averages nearly 200 more miles per load than coal to our Northern utilities. Obviously, changes in volume between the market segments will impact revenue per car for coal in our network.

Now turning next to our intermodal network. Revenue in the quarter reached $527 million, up $42 million or 9% over first quarter of 2011, driven by 5% higher intermodal volume and a 3% increase in revenue per unit. As depicted on Slide 11, the volume gains in intermodal came mainly from our domestic market, which was up 13% or nearly 44,000 loads for the quarter due primarily to highway conversions. Our international segment posted a 3% decline for the quarter, as volume reductions associated with Maersk were partially offset by trade growth. And finally, increased demand for truckload services pushed Triple Crown volume up 4% for the quarter.

As volumes within our domestic network strengthened, so did our efficiency. As shown on the next slide, we experienced marked improvement in the stacking of domestic containers during the quarter, a metric which highlights loading efficiency and equipment utilization. During the quarter, 86% of all domestic containers in our network moved on stack cars, a 9-point improvement as compared to the first quarter of 2011, creating additional capacity across the network. And total intermodal crew starts went up by 2% on a 5% increase in volume.

Wrapping up our discussion of the business groups, we'll now turn to our merchandise sector. Revenue for the merchandise group in the quarter was $1.5 billion, up $177 million or 13% over last year. This is an all-time revenue record for our merchandise sector. Our first quarter record was established for metals and construction and new all-time high records were achieved for chemicals and agriculture as well. The 13% revenue increase in merchandise was driven by an 8% gain in revenue per unit and a 5% increase in volume for the quarter.

The growth within merchandise was led by automotive, which was up 23%, and metals and construction traffic, which increased by 12%. A projected 16% increase in North American light vehicle production during the quarter, along with business gains from Volkswagen and other manufacturers, drove the growth in our automotive sector.

Our steel business was up 13% in the first quarter, as a result of rising demand from domestic production and increased import slab volumes from Russia and Eastern Europe. In addition, we saw a strong demand for frac sand into the Marcellus and Utica shale regions, which led to a 19% gain in miscellaneous construction materials.

Chemicals volume was flat for the quarter, as gains in plastics and crude oil from the Bakken and Canadian oilfields offset declines in rock salt for highway treatment due to the mild winter.

Two of our merchandise sectors experienced volume declines for the quarter. Agriculture volume was down 2% due to a fertilizer comp effect, which was not cleared until March 1. This was partially offset by a 6% increase in shipments of ethanol in spite of reduced consumption of gasoline. Paper volume was down 4% due to a weaker volume of newsprint, pulp and pulpboard, which was partially offset by gains in lumber, which was up 15% in the quarter.

Concluding now with our business outlook and our expectations ahead. For Coal, we do not anticipate the need for appreciable inventory replenishment in our utility market during the shoulder market months since stockpiles remain at target levels across our region. But we do expect offsetting demand in our robust domestic metallurgical market due to increased domestic steel production.

And on the export front, we expect new steam coal opportunities to partially offset weaker demand in the European met market. We are also encouraged by recent improvement in high-end world met coal prices, which may be signaling a tighter supply chain for this product. But clearly, in the short run, post April 1 of this year, we are pricing transportation service in this sector in a weaker international met coal market than existed last year.

In our intermodal sector, our strong service performance and tighter truckload capacity bode well for continued opportunity for highway conversions. And expectations for international trade remain favorable, as consumer confidence continues to improve.

The outlook for our merchandise business is positive, led by growth in crude oil and waste products, as well as higher volumes of ethanol to new terminals. We're also well positioned to take advantage of prospects for continued growth in the shale region. And our outlook for our steel and automotive businesses remain positive.

In summary, we expect our diverse range of markets to support overall growth ahead despite current headwinds in the coal market. We remain committed to delivering a strong service product and pricing that product at levels that equal or exceed the rate of rail inflation.

Thanks for your time, and I'll now turn it over to Mark for our operations report. Mark?

Mark D. Manion

Thank you, Don. Good afternoon, everyone. Starting with safety. We ended the first quarter with a ratio of 0.70. That's an 11% improvement over the same period last year. As we continue to reduce injuries and accidents, everyone associated with Norfolk Southern wins. Our employees have an improved quality of life. And from a business perspective, we reduce our costs and improve our operating performance. Our workforce increasingly drives improvements in safety and service.

Let me now turn to service as expressed in our composite service metric. For the quarter, we posted composite performance of 82.8%. That's a 15% improvement over last year. While led by train performance, all the components, train performance, connection performance and plan adherence, showed significant year-over-year improvement. While mild winter weather worked in our favor, improved crew availability has resulted in a big boost in operating performance. This continues a trend from the fourth quarter, where we've seen the velocity of the railroad continue to improve. First quarter composite performance, in fact, is just short of the second quarter 2009 record performance of 83.8% but with 23% more volume.

Similar to composite service metric, train speed for the first quarter improved 2.5 miles an hour or 12% over the same period last year. Again, we're approaching our record-setting second quarter 2009 velocities, but with significantly more traffic. Like train speed, terminal dwell showed a significant improvement in the first quarter compared to first quarter last year, a reduction of 4.4 hours or 17% and equal to our 2009 performance.

Turning to the last page, all of these service improvements also equate to greater velocity and consistency, and in turn, drive productivity. Let me list just a few. Train & engine service overtime has been reduced 15%. Re-crews have been reduced a sizable 35%. Equipment rents have been reduced as a whole, but the portion of equipment rents driven by velocity has been reduced by 9%. Locomotives in service have been reduced by 3%. Fuel consumption, reduced by 2%. Gross ton miles per gallon improved 1% and gross ton miles per train hour has improved 4%.

This quarter punctuates the importance of having the right resources in place to run the network. Properly applied, those resources drive service and velocity, which not only delivers a superior service product to our customers, but also productivity to the bottom line.

With that, I'll turn it over to you, Jim.

James A. Squires

Thank you, Mark. I'll now review our financial results for the first quarter. As Wick mentioned, after a balmy winter, we are off to a strong start, having set first quarter records for most measures.

Let's start with our first quarter operating results. As Don described, our 6% increase in railway operating revenue set a new first quarter record at $2.8 billion, the $169 million increase included an additional $76 million of fuel revenues, notwithstanding a $26 million unfavorable lag effect.

Railway operating expenses increased $24 million or 1% for the quarter. Income from railway operations was a first quarter record at $745 million, and the resulting 73.3% operating ratio equaled our first quarter record.

As you'll recall, our prior year expenses included a $58 million non-cash charge related to an unfavorable arbitration ruling, which contributed 220 basis points to last year's operating ratio. Excluding the arbitration charge, our 2012 operating ratio translates to a 2% or 160 basis point improvement compared to first quarter 2011.

Turning to our expenses. The next slide shows the major components of the $24 million net increase. As expected, fuel and compensation and benefits accounted for most of the upward pressure on our expenses.

As displayed on the following slide, the $24 million increase in fuel expense was due to higher prices, which were partially offset by reduced consumption. Our average diesel fuel price per gallon was $3.16, a 10% increase compared with the first quarter of 2011. Diesel fuel consumption decreased 2% relative to a 1% increase in volume and a 1% decline in gross ton miles, reflecting productivity gains achieved from a fluid network.

Next, compensation and benefits increased by $21 million or 3%. Looking at the major components of this increase on the following slide. First, pay rates drove expenses up $11 million. Second, higher, health and welfare benefits due to increased headcount added $6 million. Third, payroll taxes increased $6 million. Fourth, employee activity levels, primarily related to non-T&E crafts, increased, adding $5 million. Train & engine activity levels increased negligibly despite higher train starts and volumes. Again, displaying productivity gains from improved train operations. Lower stock-based compensation partially offset these increases.

Depreciation and purchased services and rents increased $13 million and $8 million, respectively. The 6% increase in depreciation reflects our larger capital basis, as we've continued to invest in our infrastructure and equipment. Purchased services and rents primarily reflects increased intermodal operations, repairs and maintenance and other miscellaneous services, partly offset by lower equipment rents.

Equipment rents benefited from improved velocity, our acquisition of freight cars that had been previously leased, the plans for which we shared with you last year, and the reduction of leased locomotives.

Materials and other expenses decreased $42 million or 15%, reflecting the absence of last year's unfavorable arbitration ruling, partially offset by higher materials costs, largely related to equipment and roadway repairs.

Turning to our nonoperating items. Higher interest expense on uncertain tax positions was offset by net returns from corporate-owned life insurance and other miscellaneous items. Interest expense on debt increased $8 million, reflecting additional net borrowings over the last 12 months.

Next, income taxes totaled $244 million and the effective tax rate was 37.3%. Income taxes in the first quarter of 2011 were $190 million with an effective rate of 36.9%.

Net income and EPS comparisons are displayed on the following slide. Net income was $410 million, an increase of $85 million or 26% compared to 2011. Diluted earnings per share was $1.23, exceeding first quarter 2011 results by $0.33 per share or 37%. Excluding last year's arbitration adjustment, our net income increased $49 million or 14% compared to 2011, and diluted earnings per share increased $0.23 per share or 23%. Both measures set new first quarter records.

Lastly, as displayed on Slide 13, during the quarter, we generated cash from operations exceeding $1 billion, up $383 million from last year, and also bolstered by a return to normal accounts payable flows from the accelerated activity I mentioned to you last quarter.

Cash from operations more than covered our property additions, share repurchases and dividends. Cash and cash equivalents at the end of the quarter equaled $829 million, reflecting $600 million related to our 3%, 10-year senior notes issued in March.

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

Charles Wick Moorman

Thanks, Jim. As you've heard, Norfolk Southern again posted excellent results for the first quarter, driven, as I've said earlier, by a very substantial improvement in operations, velocity and customer service, along with the continued strength in key components of our franchise. Looking ahead, we're committed to driving even higher levels of service performance and efficiencies through continued investments in assets, infrastructure, technology and most importantly, our people. We have long believed that improving service links directly to greater efficiencies and the numbers that Mark showed you are certainly confirmation of that.

Looking to our markets, we continue to believe that the United States is on a path of continued, albeit slow, growth. And we feel confident that we can continue to grow our merchandise and intermodal volumes at above the rate of total economic growth.

Coal obviously remains something of a question mark, given our inability to forecast, let alone manage, the weather. But over the longer term, we have continuing confidence in the strength of both our domestic and export coal franchises.

Our company and the great people who make up our company are working hard to deliver the best possible value to our customers and superior returns to our shareholders. We have a great team. And our first quarter results are further proof that we are achieving success in both of those goals.

Thanks, and we'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Chris Ceraso from Crédit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Let's see, a couple of items. The strength in your length of haul in the Coal business in Q2 and Q3 of last year drove some nice yield and revenue per unit. How much of a headwind do you think that creates this year in Q2 and Q3? And then if we couple that with the decline in the export met pricing and just a decline in export met volumes, do you think it's possible that revenue per unit could go negative in Coal in Q2 or Q3?

Donald W. Seale

Chris, this is Don. Certainly, last year we saw Utility South shipments and export shipments up substantially, and we faced that as a comp this year. Those are long-haul, higher RPU market segments of Coal, and they are under pressure somewhat. I had mentioned that our Utility South segment in the first quarter was down 24%. Our Utility North segment was down 11%. So there is a, that's a negative comp with respect to mix within those 2 segments. Also, our export market was off 10% in the first quarter, and that's a negative comp as well. So the revenue per unit based on that mix effect certainly could go negative if we continue to see that mix.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then maybe thinking longer term, on more of the core price in coal for the domestic thermal, what's your expectation as you look forward, as contracts start to roll over. Do you think you may have to adjust prices downward? Or is your game plan to maintain pricing in domestic thermal?

Donald W. Seale

Chris, we do not have any utility coal contracts that will be renegotiated this year. So we will have to wait to see what the market looks like when those contracts are renegotiated.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

And you're not willing to talk about next year yet?

Donald W. Seale

I think we have a ways to go to see what the market will look like by then.

Operator

Your next question comes from Chris Wetherbee from Citi.

Christian Wetherbee - Citigroup Inc, Research Division

Just maybe another question on the export coal market. From the pricing standpoint, I guess most of it will recycle on April 1. I just want to get a sense, can you give us the order of magnitude? Is it 100% of your met business that gets repriced on April 1? Or is there some pieces of business that got redone earlier this year?

Donald W. Seale

We have some of the business that is under contract beyond April 1. But the majority of the export metallurgical coal market will be repriced, after the April 1 date.

Christian Wetherbee - Citigroup Inc, Research Division

Okay. And then when you think about the mix of thermal, you mentioned thermal coming in and potentially providing some offset to the decline in the met business. I'm guessing that not much of that was moving in the first quarter. Is that a fair statement? I think you had mentioned that you'd gotten some in the month of March. But as you look forward, is that, the potential to offset that, that we didn't see in the first quarter, the down 10% number, but may come in the next couple of quarters?

Donald W. Seale

We handle 600,000 tons of steam coal into the export market in the first quarter.

Christian Wetherbee - Citigroup Inc, Research Division

Okay. And that could be a bigger number as we move forward potentially?

Donald W. Seale

Potentially, yes.

Operator

Your next question comes from Justin Yagerman from Deutsche Bank.

Justin B. Yagerman - Deutsche Bank AG, Research Division

First question on the intermodal side, just switching topics a little bit. I'll come back to coal, don't worry. But was curious, how you think about the profitability of that incremental double stacking that you were able to get in the quarter? I mean, is that pure profit as you're able to get more containers on those trains? Or how should we think about that in terms of the incremental margin in that intermodal business?

Donald W. Seale

Justin, this is Don. We realize increased efficiencies as we densify our intermodal train network. So when you look at the metrics of going up 9 percentage points in the stack configuration in the first quarter, plus having a 5% increase in volume with only a 2% increase in crew starts, both of those metrics support improved efficiency and incremental margin.

Justin B. Yagerman - Deutsche Bank AG, Research Division

Got it, so it definitely helps out on that end. And then when I think about the steam coal on the export side becoming a bigger part of the mix, can you remind us, I guess on a percent basis, what steam coal is right now as a percentage of your total export? How does that export pricing margin compare to the met side of the export business? And where exactly is that coal coming from and where is it going?

Donald W. Seale

The steam coal component and the met coal component in the first quarter, we were 93% metallurgical coal going into the export market. The steam coal that we are targeting is predominantly Western Europe. Some could make its way to Asia as well. And it originates in much of the same production territory that we originate the met coal in. So it would be Central App, Northern App, Illinois Basin.

Justin B. Yagerman - Deutsche Bank AG, Research Division

Got it. And the profitability on that relative to the met?

Donald W. Seale

The steam coal market is a different market than the met coal market. We will do fine on both segments, but it's a differentiated product.

Justin B. Yagerman - Deutsche Bank AG, Research Division

If you had one versus the other, which would you rather have?

Donald W. Seale

Both.

Operator

Our next question comes from Ed Wolfe from Wolfe Trahan.

Edward M. Wolfe - Wolfe Trahan & Co.

What are you seeing directionally in the domestic met yields going forward? What do you expect? And on the export, your closest competitor obviously posted a 12% decline in April. Is your experience similar to that?

Donald W. Seale

Ed, as you know -- this is Don again. As you know, we have our export pricing contained in contracts. And the contracts are confidential with producers. So we will not be able to discuss what the price levels of those contracts will be.

Edward M. Wolfe - Wolfe Trahan & Co.

So you won't even comment on directionally if they're similar to aggregated together relative to that negative '12 number?

Donald W. Seale

Ed, we cannot because they are contained in confidential contracts.

Edward M. Wolfe - Wolfe Trahan & Co.

Okay. On the domestic met side, on the domestic side, what are you seeing or expecting? And how much of that business is contract? How much potentially comes up?

Donald W. Seale

Well, we were up 19% in the first quarter on domestic metallurgical coal, and we're seeing our domestic steel market continue to improve. It was up 7% in the quarter in terms of production, and steel capacity, manufacturing capacity, is now running at 80%. They still have room to move up. We have an automotive market that's extremely good, and the steel market is following that. So we see good opportunity in the domestic met market. I'll put that into context a little bit, Ed. In the first quarter, we were down essentially 700,000 tons of metallurgical coal going into the export market. We were up 800,000 tons of coal going into the domestic metallurgical market. So...

Edward M. Wolfe - Wolfe Trahan & Co.

But in terms of pricing, not volume -- obviously, the volume is good. But what are you seeing on the pricing side? And what percentage of that business reprices throughout this year?

Donald W. Seale

We have most of that business priced for the year and we're pleased with the pricing levels.

Operator

Our next question comes from Tom Wadewitz from JPMorgan Chase.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

I wanted to ask you on export coal that -- I think there's some recent data points that indicate maybe the market's improving a little bit on the met side. That pricing, I think $210 a ton, something like that, looked like it bottomed or popped up a little bit. So as you look at your export met in second quarter, do you think that, that potentially improves? And perhaps, you can comment on what March will look like. I think your January, February met export was down. But maybe you can tell us what March looked like.

Donald W. Seale

The latter part of that question first, Tom. This is Don. Our January export numbers were pretty close to our January 2011 numbers. We were down in February significantly, and then back up close to 2011 numbers in March. So it was a choppy distribution of traffic. To the first part of your question, we have seen in recent weeks the metallurgical coal price in the world market move from $210, an increase of about $10 a ton, back up to about $220 on the high-end of met coal coming out of Australia, so that is encouraging. The second thing we're seeing in Australia is that during the latter part of March, we had heavy rains, floods and labor disruptions and we've seen some force majeure of metallurgical coal for BHP and others coming into the market. So we're not declaring that the market is turned, but those signals are positive for us.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay. And on the utility side, you sound like you're, I guess, relatively optimistic given that the environment is so difficult. Do you think that utility, year-over-year, is going to get worse in second quarter? Or you feel like it's kind of a similar year-over-year decline to what you had in the first quarter? And then, I mean, it's tough to look out to second half, but if you have a normal summer, you think things might actually improve in second half? Or is that tough to figure out from this point?

Donald W. Seale

Tom, first of all, with -- let's talk about the comp. In the second quarter versus the first quarter, our comp for utility coal for our network will be a little less demanding than it was in the first quarter. We handled 2 million tons more utility coal in the first quarter of 2011 than we did the second quarter, so the comp will not be quite as high in the second quarter, so that's favorable, but by about 2 million tons favorable. The shoulder months, however, with inventories being as high as they are at the utilities because of the mild winter, we expect a very soft shoulder month period, with very little replenishment taking place, so the second quarter will be impacted by that. If we see a normalized weather pattern going into the summer -- in fact, we're hoping for something that's under the term hot and sweltering. If that were to be seen, we could see coal pick back up and, certainly, the second half of the year would be on a better track.

Operator

Our next question comes from Matt Troy from Susquehanna Financial.

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

Just a quick refresher. I'm not -- I don't think you have any thermal contracts or any major thermal contracts coming up for negotiation this year. Is that correct?

Donald W. Seale

Mark (sic) [Matt], this is Don. That's correct.

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

So if I look at your negotiating strategy, obviously nat gas is going to remain low for some time no matter whose model or forecast you look at. And stockpiles of 200 million, 210 million tons are a record for this time of year and we are going into the shoulder. Are you getting any change in posturing from utility customers? Are they looking for forgiveness on take or pay or negotiated minimums? Are they pushing back on price? Just what does the environment feel like when you talk to utilities that clearly don't want or need any more coal at this point in the year?

Donald W. Seale

This is Don. We're continuing to have discussion, as we always do, about supply chain management of their requirements. We are not engaged in contract discussions.

Matthew Troy - Susquehanna Financial Group, LLLP, Research Division

All right. Okay. And then second question would be -- when we were there about a month or so ago, we talked about the resource being -- the network being adequately resourced from a headcount perspective, able to accommodate mid- to high-single digit volume growth, numbers today bear that out. Just curious, as we think about modeling for the rest of the year, headcount relatively flattish, incentive, comp seems to be a variable, hitting people this year to varying degrees. Your stock did exceptionally well last year, but may be a more difficult comp later in the year. But I'm just wondering, the moving parts and pieces on labor expense, what should we expect in terms of wage inflation? And any potential change in what incentive comps doing in that labor line?

Charles Wick Moorman

Well, I think you've already heard from folks that if you look at those components, health and welfare benefits, moderate a little bit this year. Headcount, we do feel that we've really gotten our workforce about back up where it needs to be from a T&E standpoint, and we'll still be hiring, but hiring more based on attrition, so that's flattening out. The incentive comp, we just have to wait and see. It's still early in the year to understand exactly what it'll do. Jim, your thoughts?

James A. Squires

We would foresee continued favorability in incentive compensation. But not to a material degree. Somewhat similar to what we saw this quarter, so about $10 million in the quarter.

Operator

Our next question comes from Walter Spracklin from RBC Capital Markets.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Just a question, you've dealt with the sort of the pricing effect from your coal. I was wondering if you could look outside your coal market and look at general pricing and sort of give us an indication of the impact that perhaps mix had outside of coal on your quarter. Was it favorable or unfavorable? And do you expect that mix effect, again ex coal going forward, to either continue in that same trend or not?

James A. Squires

Walter, it's Jim. Mix was unfavorable this quarter overall, not surprising given the growth rates in the varying commodity groups. And that's been the trend for some time now, so I see no reason to believe that, that won't continue to be a drag on overall yield as the year goes on.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Any order of magnitude as it comps with your 5% RPU?

James A. Squires

It was about 2% negative.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

2%, that's great. And I don't if I missed it, but headcount in terms of just wage inflation, what are you modeling for this year, just, not on headcount but on your wage inflation?

Charles Wick Moorman

We're in the 3% range, something like that. All of the contracts have been ratified, and that's giving us a lead on that number.

Operator

Our next question comes from Jason Seidl from Dahlman Rose.

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

Quick question. In relation to the weather in 1Q, obviously, there's a little bit of an offset for the negative demand on coal in that your operational metrics'll look a lot stronger because of the decent weather conditions. Could you talk a little bit about -- as we head into Q2 here and should we still see continued operational performance but maybe just not along the same magnitude as Q1. Is that how we should look at it?

Mark D. Manion

Yes. This is Mark. We expect to continue to see the kind of velocity improvement that's been ramping up. And in fact, that really has been going on since November last year. We saw some pretty good velocity year-over-year, fourth quarter, and fortunately, that's continued on through winter. And now as we get into the second quarter, we're just -- we're seeing the same, where we've got velocity improvements that are pretty significantly better than last year, even though we're out of the winter season.

Charles Wick Moorman

I think we feel relatively confident, barring unforeseen events that we have the assets and people in place to continue to operate the network at the metrics that we saw from the first quarter. There will always be aberrations, but we think we're adequately staffed and we have good power and all of the systems in place to continue a high level of network performance and customer service.

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

Okay. And my next question, guys, is in the intermodal side. Obviously, you lost a contract on the international front. Could you talk a little bit about your domestic business? The outlook, competing with trucks? And also in terms of where we are in the network? How much capacity you have left to grow that before you have to start adding some assets?

Donald W. Seale

This is Don. The domestic segment was a high growth segment again in the first quarter. It was up 13%. The driver of that is Eastern, local, intermodal growth, which is highway-diversion based. And we see a very large pool of motor carrier traffic that's available for continued conversion. As we open our new intermodal terminals this year, we'll be adding close to 750,000 additional lift capacity at those terminals. So we have good capacity coming with the new terminals. We're handling the business that we have today very effectively. So we're encouraged by that. We're optimistic about further growth. With respect to the intermodal train network, it's notable when we look at the train capacity, with the densification effort and the stacking effort that we have underway, our train length in the first quarter only increased by about 50 feet per intermodal train, and we handled 38,000 additional units of business in the first quarter. So less than 1% increase in train length with a 5% increase in volume.

Jason H. Seidl - Dahlman Rose & Company, LLC, Research Division

And that's all the benefit from the double stacking?

Donald W. Seale

Correct.

Operator

Our next question comes from Brandon Oglenski from Barclays Capital.

Brandon R. Oglenski - Barclays Capital, Research Division

Maybe if I can just follow up on that, Don. What are some of the impediments today that keep you from double stacking more of the domestic container traffic?

Donald W. Seale

Well, the impediment to this point has been the availability of 53-foot well cars, having them at the right place, having sufficient containers in the pool to completely move our domestic freight in containers for stacking. When we talk about our domestic freight, by the way, I'm not talking about our premium segment, which is UPS and FedEx, they move predominantly in trailers. We're talking about our domestic market that is highway conversions for Hunt, Hub and others. We're now -- 93% of that market is moving in containers. So as we've increased the container pool, increased the 53-foot well car pool, as well as focused on getting the right car at the ramp at the right time and getting the right box on those cars, those metrics are moving in the right direction.

Brandon R. Oglenski - Barclays Capital, Research Division

Okay, but there's no structural impediments like clearances or tunnel heights that you have to get it across right now?

Donald W. Seale

We're 97% cleared for double stack across our entire network.

Brandon R. Oglenski - Barclays Capital, Research Division

Okay, and then just one last one on coal, if you don't mind. For the domestic utility contracts, I know you said that there's not any that you're going to be repricing this year. But obviously, there's built in escalation on a lot of those contracts. Do any of them mimic what we're seeing right now with RCAF x fuel? Or should we be thinking differently from that?

Donald W. Seale

RCAFs, as a percentage of our book of coal has become de minimis.

Brandon R. Oglenski - Barclays Capital, Research Division

Even the ex fuel, like core inflation?

Donald W. Seale

Correct. We're not using RCAF to any great degree now on coal contracts.

Operator

Our next question comes from Ken Hoexter from Bank of America Merrill Lynch.

Ken Hoexter - BofA Merrill Lynch, Research Division

If I can just take on the intermodal for a second. Can you talk about the scaling of these yards as they come on the 4 yards that you're launching? Is that all a fourth quarter event? Are we going to see the benefits come on through the rest of year? Can you kind of just walk us through the time and the magnitude of that growth?

Charles Wick Moorman

Of the 4, Ken, we have already turned on our operation at Mechanicville, New York for our joint venture with Pan Am. That's been a significant improvement for us, because we can now stack all the way out of Chicago into Mechanicville, and only are now restricted into Ayer. That's online. We are optimistic that we're going to get the new terminal at Memphis up and running to, maybe to a limited degree, initially. But up and running, hopefully, sometime mid, late summer. And then the last 2 terminals in Rossville, Memphis, Birmingham and our terminal in Greencastle, are order of magnitude, all the same in terms of capacity -- I beg your pardon, Birmingham and Greencastle, Pennsylvania, are fourth quarter completion.

Ken Hoexter - BofA Merrill Lynch, Research Division

And this is an event where you see the growth once it's live? Or is there anything incremental that you work around that as -- or does it all start on day 1 when you launch?

Charles Wick Moorman

If you look at our existing terminals in that part of the world, we are largely operating at capacity today. We expect, when the new terminals are open, that they -- there's a lot of business that will move and it will ramp up very quickly, but we're not going to see much more incremental growth in those lanes prior to the opening of those terminals.

Ken Hoexter - BofA Merrill Lynch, Research Division

Appreciate that. And then just switching subjects for my follow-up on agriculture. Is this -- are we -- what do you see, I guess, Don, in terms of starting to overlap these negative comparisons? Are you starting to see the planting season go your way? Can you kind of get an early read on how things are trending there?

Donald W. Seale

Yes, Ken. The comp that we faced in ag was a phosphate rock move in Florida, and we did clear that negative comp, March 1. Now with respect to the crop, we expect a very, very solid corn crop planting. The season is already off to a pretty good start weather-wise. And if we get the proper amount of rainfall and the type of growing season that we would normally expect, it's going to be a very large crop. And as you know, the soybean crop and the corn crop in South America was substandard this past season. So we should see an export market from the U.S. on the horizon that should be much stronger than the export market that we saw this past year.

Operator

Our next question comes from Bill Greene from Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

I know your outlook longer term on the Coal business is pretty good. But if things sort of struggle for a bit here, how quickly can you move resources around the network? Are there friction costs we need to be thinking about? Or is it pretty seamless, that you can move to where there's growth?

Charles Wick Moorman

No. The resources that we employ in that business in terms of -- primarily locomotives, obviously, can be moved very quickly. In terms of people, we manage through that, obviously, those are folks that we can move temporarily if we get short somewhere else, but don't usually do that. And the balance is just coal cars, which we don't deploy in any other business. So there's really not much in what I would describe as frictional costs.

William J. Greene - Morgan Stanley, Research Division

Okay. And if we had to make a decision, sort of longer term, about the coal franchise, is there a lot of CapEx that's tied up in that in each year's plan that you could sort of pull out if you decided, this is going to be sort of 3/4 of the size it once was? How much flexibility do you have there?

Charles Wick Moorman

We actually have a fair amount of flexibility. As you know, Bill, we have been working on for a few years now and continue to work on the replacement of our coal car fleet, which is life expiring essentially over -- and we'll continue to do so over the next 5, 6, 7 years. We can throttle that program up and down. We can certainly curtail it if we feel that we need a smaller car fleet than we currently have today. So we do have flexibility in terms of that primary asset, our coal cars, over the next few years to really manage the size of the fleet to where our business is going to go.

William J. Greene - Morgan Stanley, Research Division

All right. That makes sense. And then, Wick, last question is just on the regulatory angle. Last year, the STB looked at various commodities and talked about should they all be exempt and what's sort of the thought process here. Is there ever a case to make here that because of the fact that natural gas is so competitive now that maybe coal regulations need to be revisited? That maybe there's not as much of a reason to be as aggressive there?

Charles Wick Moorman

Well, that's a very interesting argument, which I'm now going to think through and try to progress. But it's never been suggested in front of the board that there's a case to be made to do that.

William J. Greene - Morgan Stanley, Research Division

But that's happened for other commodities, no?

Charles Wick Moorman

Was anything exempted post the original exemptions that were published?

Donald W. Seale

Well -- this is Don. The STB, in the 80s, after staggers, had product and geographic competition.

Charles Wick Moorman

Right.

Donald W. Seale

As 2 of tests for regulation of commodities and exemptions. So I guess if gas continued to be below $2, we could certainly argue that we're seeing very, very robust competition from a product side as well as geographic.

Charles Wick Moorman

Right. The board has, as you say, reexamined exemptions last year, has made no changes. But I think Don is exactly right on the criteria. I don't recall them ever modifying, in any significant way, the exemptions since they were first established.

Operator

Our next question comes from Anthony Gallo from Wells Fargo.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

Two questions, both around shale. You mentioned records within metals and construction. If you stripped out the metals piece of that, what did the construction look like? And obviously, my angle is what's going on with the frac sand.

Donald W. Seale

We had a very solid quarter in the first quarter with frac sand and related materials going into Marcellus for the drilling operation.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

And then, I'm sorry, go ahead.

Donald W. Seale

Go ahead.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

I was just going say, as a follow-up, can you give us a little detail behind that, I believe it's Wisconsin sand but destination, length of haul and maybe what the competition looks like, I know truck and barge does very little. Up in that area, it's mainly other regional railroads, although CSX does some. Just a little color around the competition.

Donald W. Seale

We are handling a lot of Illinois and Wisconsin originated sand that comes to us over the Chicago Gateway. So it's an attractive length of haul from Chicago back into the drilling region of Pennsylvania and associated areas. So the competition, obviously, there's some truck competition, but we have a very favorable position with respect to those bulk commodities hauling at that length of haul. And we expect that, that volume to continue to grow, not only in the frac sand but drilling pipe, drilling pads, as well as the potential for handling wastewater.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

And then do the Canadian rails play up there as well, to some degree?

Donald W. Seale

The CP is involved in some of that business as well.

Anthony P. Gallo - Wells Fargo Securities, LLC, Research Division

It sounds like it's largely an NS market.

Mark D. Manion

We have a very strong position in Pennsylvania, both from an NS standpoint and our standpoint of short line partners, as we do in southern New York, which accesses a lot of that market.

Operator

Our next question comes from Peter Nesvold from Jefferies & Company.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Most of my questions in the quarter have been answers. Are you able to tell us what percent of your revenue for this year has been contracted as of the end of 1Q? And what percent of the revenue by the end of 2Q will have been contracted?

Donald W. Seale

This is Don. With respect to the end of the first quarter, 75% of our book for the year has been contracted. I will wait on the answer to the second part, because we want to see that we've got all the negotiations done before I declare them done in the second quarter.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Okay. And then just as a quick follow-up, the industry rail car data came out yesterday. And I think one thing, though, a bit of surprise, is that steel coal cars were actually pretty good, which was a little bit of a surprise given what's happening obviously in coal right now. How do you -- you talked a little bit about this earlier, your flexibility to redeploy capital if coal, as a franchise, goes into secular decline. In the nearer term, in the next 2 to 4 quarters, how do you think about deploying capital into that business? I mean, do you hold off on ordering additional cars until you kind of see where volumes are going? Or is it just no change to the base case CapEx scenario for now?

Charles Wick Moorman

In terms of thinking about replenishing our coal car fleet, we look at a couple of things. One is what is the fallout rate of the existing fleet. And then, obviously, over the longer term, what's the total number, the fleet that we -- the coal cars that we require in the fleet for the business. We have a lot of ability to flex over the next few years. In the shorter term, we have made some contractual commitments and we are also looking at our fallout rate, and we are ordering accordingly. So -- every year is a new year. We'll take a hard look at it again next year and see what we need to order.

Operator

Our next question comes from David Vernon from Bernstein.

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

I just wanted to get a sense for where we are with respect to automotive volumes on 2 fronts. First, what you're hearing from customers in terms of how much pent-up demand remains to be filled? And then, on the second side, if you're also hearing that there's additional site relocation closer into the North American market for new vehicle production?

Donald W. Seale

David, this is Don. With respect to the first part of the question, our dialogue with our automotive customers is a very positive dialogue. We're seeing annual production look closer to 15 million units on the run rate that we're on right now. Certainly, our first quarter volumes being up 23% in that market reflects that demand. The average age of a vehicle on the U.S. highway today is 10.5 years old. So there's still room to run, with respect to replenishing that older fleet. So what we're hearing from our customers is pretty positive. With the second part of your question, we continue to have dialogue with manufacturers that are looking at possible expansion into the U.S. market for automotive production. We're seeing that in a positive way across manufacturing in general, as we see some of the re-shoring activity that's taking place. As Asian production continues -- that cost of production in Asia continues to get higher, the U.S. and Mexico are looking much more favorable to new plant locations for manufacturing in general.

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

Any specifics stuff in the automotive side that's on the planning calendar so far?

Donald W. Seale

Well, we couldn't comment with respect to any of the manufacturers that might be looking for plant sites since that's very confidential information.

David Vernon - Sanford C. Bernstein & Co., LLC., Research Division

All right, great. And then maybe just as a quick follow-up, for Jim. What was the fuel surcharge revenue in the quarter?

James A. Squires

David, the fuel surcharge revenue was $325 million versus $249 million in the first quarter of 2011, a $76 million increase.

Operator

Our next question comes from Jeff Kauffman from Sterne Agee.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Sal Vitale on for Jeff Kaufmann. Just a quick question on the coal side, can you provide the breakdown of the utility coal tonnage between North and South?

Donald W. Seale

It generally runs about 50-50 with respect to the split in terms of the overall volume. Of course, this past quarter, we had one down 24%, Southern utility, and the North was down 11%. So it moves quarter-to-quarter based on that mix. But generally, on average, 50-50.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Okay. And then I'm just trying to get a sense for the difference in revenue per car between met coal and utility coal, that is if similar length of haul profile. So if we assume, say, a 300-mile length of haul as a point of reference, what would be the approximate difference in the revenue per car?

Donald W. Seale

I think you can look at the slide that we presented on relative mileages. And revenue per revenue ton mile would track somewhat those relevant differences in mileage.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Right. So if I'm looking at the right slide here, Utility North is roughly half of Utility South? So you're saying that's a good starting point?

Donald W. Seale

As we've said in the past, our Utility South business is about 1/3 higher revenue per unit than our Northern utility.

Salvatore Vitale - Sterne Agee & Leach Inc., Research Division

Just one other question. On the fuel surcharge, has there been any increase in coverage on the surcharge side? So you said the $76 million was the absolute dollar increase, I'm just trying to get a sense for how much of that is attributable to higher coverage.

James A. Squires

Effectively 0. We have a very good coverage and the number's not changing.

Operator

At this time, we have no further questions. I'd like to turn the call back over to Wick Moorman for any closing comments.

Charles Wick Moorman

Thank you for your questions, and we look forward to talking to you next quarter. Thanks very much.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Norfolk Southern's CEO Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts