Remarks from the Financial Analysts' Meeting
New York, NY - January 24, 2007

• Presentation Slides • Presentation Slides

Remarks by: • Wick Moorman • Henry C. Wolf • Stephen C. Tobias • Questions and Answers

Remarks by:

Donald W. Seale
Executive Vice President and Chief Marketing Officer
Norfolk Southern Corporation

Thank you Hank and good morning.

My comments will highlight the key factors that drove our markets and results during the past year and offer some insight as to what we see ahead in 2007. 

First, some general comments about the economy.  We all know the economy was in transition during the past year. The outlook was favorable in the first quarter, mixed in the second quarter, and growth slowed in the last half of the year.  Due to a weak housing market, fourth-quarter GDP growth continued to track below trend at 2.4%. But, improving net exports, business investment, as well as stronger than expected consumer spending, helped offset some of the downward pressure.

Compared to modest growth in GDP, the signals were less positive from the manufacturing industry, where fourth quarter output showed the first quarterly drop since the second quarter of 2003. The ISM index reflected this decline by dropping below 50 in November for the first time since April of 2003.

Weakness in the housing market will continue to slow growth in 2007, with annual GDP expected to be at its lowest pace since 2002. With the economy growing below its potential, we expect the manufacturing sector to be weaker in the first half of the year as well.  However, a weak dollar, continued strong corporate earnings, and low interest rates should support continued business investment and boost factory production in the final two quarters.

Our performance in 2006 reflected the moderating economy, despite new business and development projects.

Volume in the fourth quarter reached 1,928,000 units, falling 3% below 2005, and for the year, volume of 7,901,000 units grew 1%.

Agriculture was the only sector producing year-over-year gains throughout the year, and accordingly saw record volume despite difficult comparisons to 2005. Intermodal, Metals & Construction, and Coal produced record volumes for the year, as well.

Automotive comparisons were consistent, with four quarters of declines, while our other sectors experienced some variation during the year.  And most notably, after nineteen consecutive quarters of gains, our Intermodal sector produced its first year-over-year volume decline since the fourth quarter of 2001. 

For the quarter, revenue reached $2.319 billion, increasing $62 million, or 3% over 2005.  For the year, revenue of $9.407 billion grew $880 million, or 10% over 2005.  All of our business groups posted record revenue for the year, with the exception of Automotive, which ended the year within 2% of record revenues.

Revenue per unit reached a new high of $1,203, an increase of $65, or 6% over fourth quarter 2005.  Increased pricing produced all of the improvement in RPU for this quarter, as fuel and mix were both flat.
 
We continue to successfully re-price expiring business across all sectors. As indicated in previous reports, we re-priced about 50% of our book of business during 2006.  We estimate that about half of our book of business will also be re-priced in 2007.

Turning to our markets, Coal established both record volume and revenue in 2006.  Volume for the quarter reached 439,000 loads, up 4%, and for the year we handled a record 1,760,000 units. Coal produced its second highest revenue quarter, reaching $592 million, an increase of $68 million over the same period in 2005.  For the year, record revenue of $2.3 billion exceeded 2005 by $215 million.

Revenue per car reached $1,349, up $113 over the fourth quarter 2005, and for the year, revenue per car of $1,324 increased $105 over 2005. The higher revenue per car resulted from improved pricing across all markets, fuel surcharge, favorable mix, and improvement in tons per car.

Coal, coke and iron ore carloads have now increased in ten of the past twelve quarters.  For the fourth quarter, 78% of our carloadings originated on NS lines, and 79% for the full year.

Utility volume increased 4% in the quarter despite a 1.6% decline in electric generation in our service region due to mild weather.  Stockpile rebuilding and a 37% carload increase from the western PRB coalfields contributed to the volume gains.  The increase in western coal was enabled by improved train cycles times, some of which displaced barge traffic.  In addition, import coal carloads via the port of Charleston, South Carolina increased 92% compared to fourth quarter 2005. 
 
For the year, record utility volume increased 40,600 carloads, or 3% over 2005. Western origin coal was up 29% for the year, while import volume through Charleston grew 75%.

In the short term, utility coal demand in the first quarter of 2007 is expected to be consistent with fourth quarter 2006.  However, the market will most likely soften as a result of persistent mild temperatures in the East and above average stockpiles.  

Export coal had its highest volume quarter of the year reaching 32,400 carloads, up 13% or 3,600 cars. For much of the year, overseas receivers completed delivery contracts for non-U.S. coal.   Many of these carry-over deliveries were completed in the fourth quarter, which increased demand for U.S. coals.  
 
For the year, we handled 119,000 carloads, down 14%, as shipments declined through Lamberts Point and Baltimore.

Projections for export coal tonnage for the first quarter 2007 continue to be volatile. While ocean freight rates from the U.S. versus Australia favor U.S. coal into European steel markets, higher mining costs will likely limit gains for U.S. coals. 

Domestic metallurgical coal, coke and iron ore, volume reached 52,000 carloads in the fourth quarter, down 3% primarily due to a blast furnace outage.

For the year, carloads reached nearly 218,000, up 4%, or 8,300 cars.  Increases in metallurgical volumes were due to the high demand for steel, which offset a 15% decline in iron ore carloads caused by the shutdown of blast furnaces at a major customer location.

With respect to our carload business, Merchandise revenue reached $1.2 billion for the quarter, up $20 million, or 2% over fourth quarter 2005, despite a 6% decline in volume.  For the year, revenue reached $5.1 billion, growing $520 million, or 11% over 2005. 

Revenue per car reached an all time high of $1,820 for the quarter, principally driven by price increases that were slightly offset by lower fuel surcharge revenue.

For the year, revenue per car of $1,770 was up $187, or 12%, driven by price increases and fuel surcharge revenue. 

Weakness in housing, the manufacturing sector, and automotive industry held down volume comparisons. Volume growth in the first half of the year could not offset significant declines in the fourth quarter for all groups except Agriculture.

Our Agriculture group had the most consistent volume performance throughout the year, principally due to increased ethanol and corn shipments, and also achieved the highest growth rate in revenue of any of our business groups.  Revenue reached $252 million for the quarter and $994 million for the year.  

As you know, demand for ethanol has risen sharply, and accordingly our shipments grew by 74% or 16,500 carloads in 2006, and we expect this growth to continue.

Metals and Construction revenue grew to $269 million in the fourth quarter and $1.2 billion for the year.  Volume rose 5% for the year, despite a 7% decline in the fourth quarter.

Demand was strong during most of 2006, driven by domestic steel production, commercial & highway construction projects, and new business. Iron & steel shipments led growth with a 21% increase for the year, followed by a 7% gain in scrap metal and 13% gain in cement. Growth from slab steel shipments was significant as we ran 616 slab trains in 2006, up 63% over 2005.

The fourth quarter decline in steel volume reflected lower production at domestic steel mills in response to lower steel prices and higher inventory levels. Looking ahead, domestic steel production is expected to remain soft during the first quarter, with improving conditions expected in the second half.

Paper revenue reached $222 million for the quarter and $891 million for the year on volume declines of 5% and 1% respectively. We continue to see strong growth in the market for waste transportation, including municipal solid waste and construction and demolition debris, with shipments up 39% for the quarter and 61% for the year.

In conventional paper and forest markets, printing paper led volume increases, growing 9% for the quarter and 10% for the year, primarily due to continued growth in import traffic.  Losses were mainly attributed to declines in housing starts, with lumber shipments down 15% in the fourth quarter and 4% for the year.

Chemical revenue grew to $266 million for the quarter, up 9%, and $1.1 billion for the year, up 10%, despite volume declines of 2% and 4% respectively. For the quarter and year, volume declines resulted from a work stoppage in the tire industry, inventory adjustments, the slowing housing market and plant closings.

The outlook for 2007 is one of improvement. We expect growth opportunities from plant expansions in North Carolina and Virginia and a new Thoroughbred Bulk Terminal (TBT) facility in Somerset, Kentucky.

Automotive revenue reached $225 million for the quarter, falling $29 million below fourth quarter 2005.  For the year, revenue of $974 million fell $23 million, or 2%, below 2005.  Automotive volume declined 16% for the quarter and 9% for the year as North American vehicle production fell 8% for the quarter and full year production of 15.2 million units fell 3% versus 2005 and was the lowest production year since 1996. 

Looking ahead, we expect increased shipments for Toyota and the other “New Domestics” to partially offset the impact of the Big Three restructuring in 2007.

Concluding with Intermodal, revenue reached $493 million for the quarter, down $26 million, or 5% versus fourth quarter 2005. For the year, record revenue of $1.97 billion was up $145 million, or 8%.

Intermodal volume continued to moderate during the fourth quarter, down 3% due to softening in housing and automotive, coupled with higher motor carrier capacity.

As you can see in the Morgan Stanley truckload freight index depicted here, significant variation in truck capacity occurred between 2005 and 2006.  In late 2005 the industry saw a trend of tight capacity which started to reverse itself in the first half of 2006.   For the remainder of 2006 slowing demand created excess truck capacity in the marketplace, which is continuing in 2007 with the index now below 2003 levels.  

Accordingly, our combined truckload and domestic IMC volumes declined 4% in the fourth quarter and 2% for the year. IMC carriers saw continued declines across the sector due to increasing truckload availability and downward price pressure in the spot market.  

The expectation for our domestic and truckload business in 2007 is for continued market pressure, but moderate growth.

International volume fell 1% for the quarter, but was up 9% for the year.  Our East Coast port volume was up 4.5% for the quarter, while West Coast port volumes fell 3.3%, reflecting a shift of trans-continental business to local and short haul markets through east coast ports, as well as a general softening of the market.  In addition, steamship line industry consolidation experienced earlier in the year continues to have an unfavorable impact on our mix of business.

In 2007 we expect growth to resume in this segment as we renegotiated several of our international customers’ contracts in late 2006 that are anticipated to generate improved pricing as well as new volume for our network this year.

Premium Intermodal business was down 14% in the fourth quarter and 3% for the year, primarily among LTL shippers who are currently struggling to fill capacity.

And Triple Crown expanded its business in each major segment with the exception of auto parts. With automotive business impacted by assembly plant closures and cutbacks, Triple Crown has redeployed assets to accelerate growth in consumer products, which are expected to offset the impact of lower automotive volumes in 2007.

Looking ahead, we expect continued moderation in our Intermodal markets in early 2007, but higher levels of growth as the year progresses.   Systemic factors in the trucking industry such as higher costs of operations, highway congestion and driver availability are not expected to materially improve.  Increased long term freight demand and a recovering economy provide a positive outlook for Intermodal growth.  As such, we remain committed to investing not only to improve Intermodal service levels, but to advance our strategic capacity initiatives such as the Heartland Corridor and the Columbus Rickenbacker Logistics Center. 

We continue to view Atlanta and the Southeast as a growth market and are moving ahead with our KCS joint venture and enhancements at our Southeastern terminals, including Atlanta.  Our announcement this week of improved Blue Streak train service from Los Angeles to Atlanta with Union Pacific, and our plans to add new service over Shreveport later this year bode well for this market.

In summary, our results reflect our balanced portfolio with volume growth in four of our sectors offsetting declines in the remaining business units.
 
Looking ahead, our markets will be mixed. 

The opportunities and growth potential for Intermodal are strong. Options for shippers are increasing, with all water service through the Panama canal, and new Suez service from Asia should boost Intermodal freight for eastern railroads.

Predicting the performance of our Coal market is a little more difficult.  As always, utility coal demand is somewhat dependent on the weather, while export coal will be impacted by the dynamics in the international markets. 

And our carload sector will be shaped by the manufacturing economy which will see some weakness in the short term, particularly for housing starts and automotive and steel production. 

Despite a slowing economy, the fundamentals of the rail industry remain solid.  Continued infrastructure improvements to enhance capacity and service positions us well for further growth, and we fully expect to capitalize on the opportunities ahead.  And to that end, Steve will now review our current operations and capacity planning. 

Remarks by Stephen C. Tobias >>