Donald W. Seale
Executive Vice President and Chief Marketing Officer
Norfolk Southern Corporation
Thank you Wick, and good morning.
With a weaker economy, transportation demand in the U.S. has been falling across both the rail and trucking industries. January housing starts were the lowest in a decade, and continued softness in the consumer and manufacturing sectors, combined with inventory overhang in the retail sector have produced the lowest freight volumes seen in the past several years.
During the first quarter, we were not immune to this trend as excess truck capacity in the marketplace, weak housing, cuts in automotive production and the effects of adverse weather all combined to suppress volume across our network.
Railway Volume 2007 vs 2006
When we last met in January, I presented our view that we would see softness in our volumes for the first half of the year. During the first quarter, the economic headwinds that I just mentioned and operational issues from severe weather conditions in our service area drove declines across all of our business groups with total volume down 86,000 carloads or 4%.
As you all know, we also faced a very strong comparison from the first quarter of last year which was our best first quarter ever in both volume and revenue. As a point of comparison, first quarter 2006 volume was up 94,000 units, or 5% over 2005. Our first quarter 2006 volume actually exceeded fourth quarter 2006 peak season traffic by 2% and was within 2% of third quarter totals as well.
Automotive & Housing Losses
Weakness in the housing and automotive sectors had the greatest impact on volume for the quarter and accounted for over half of our decline. Losses were experienced across the board in all of our business groups.
Housing related declines ranged from chemicals used to produce PVC pipe, to insulation and roofing materials. Also, lumber, plywood, wallboard, gypsum, sheet steel and construction related commodities such as aggregates and cement were down in the quarter.
Railway Operating Revenue
Accordingly, after 19 consecutive quarters of growth in revenue, these lower volumes produced total revenue of $2.2 billion, down $56 million or 2% below the first quarter 2006. Automotive and post Katrina spot traffic represented $76 million in year-over-year revenue loss.
Reduced fuel surcharge revenues associated with the lower volumes handled in the quarter and the lower average price of crude oil also contributed to the decline in revenue. Average price realized was up 4%, or $82 million in the quarter.
Revenue Per Unit
In spite of the impact of negative mix and fuel surcharge, revenue per unit reached $1,201 – up $25 per unit, which represents our 18th consecutive quarter of RPU growth.
Non-recurring traffic associated with Hurricane Katrina, which had a high RPU, but also high associated expenses, impacted RPU for Agriculture, as well as total revenue per unit. Without the negative mix effect of this traffic, total RPU for the quarter would have increased by 4% compared to first quarter 2006. Please see our website where we have reconciled our reported results with those excluding this non-recurring Hurricane Katrina traffic.
Coal Variance Analysis
Turning to our individual markets, Coal revenue of $557 million was flat versus first quarter 2006 as volume declined 4%.
Revenue per unit grew by 3% for the quarter, reaching $1,326 as a result of rate increases and higher tons per car, which was partially offset by lower volumes of higher RPU met coal.
Coal Volume 1Q 2007 vs 1Q 2006
Within the segments, utility volume was down 3% in carloads versus first quarter 2006. Severe winter weather in February and associated service disruptions led declines at northern utility plants. However, those losses were somewhat offset by increased volumes at power plants in our southern network.
Because of cold weather in February and early March, coal fired generation has been strong, but stockpiles remain relatively at target levels at most utility plants.
Export and Industrial coal shipments were both strong in the first quarter, with gains of 4% and 17% respectively.
In the export segment, demand for U.S. coal has increased recently in the face of vessel loading delays at Australian ports and a weaker U.S. dollar.
Industrial coal was up 17% compared to the same period last year. Improved pricing, new business and stronger demand were the primary factors that drove this market’s growth.
Met coal, coke and iron ore volume was down 23% for the quarter. Coking furnace outages resulted in lower volumes of metallurgical coal throughout the quarter and caused coke to be stockpiled or diverted to alternate destinations. Spot movements of iron ore and imported coke handled last year contributed to the decline as well.
Merchandise Variance Analysis
Turning to our carload business, Merchandise revenue of $1.2 billion fell $50 million or 4% below strong first quarter 2006 revenue. Weakness in housing and construction related materials, along with lower automotive and post-Katrina spot business suppressed volume comparisons by 8% below last year.
Despite the total revenue and volume declines, Merchandise recorded its thirteenth consecutive quarter of revenue per car growth, gaining $76 or 4%. Continued strong market-based pricing drove the improvement in spite of the loss of higher RPU business handled in 2006.
Agriculture Revenue & Units
Within the Merchandise group, Agriculture revenue of $241 million for the quarter was down $23 million, or 9%, while volume fell 2%. Excluding spot shipments last year for hurricane relief, total Ag revenue in the quarter would have been up 8% and RPU would have grown by 5%. This particular business included the cost of loading and unloading in the rate which produced a higher than average RPU.
On the plus side, ethanol volume continued to grow, up 27% in the quarter as business to the Northeast and mid-Atlantic markets expanded. Also, the expected 15% increase in 2007 corn acreage as a result of increased demand for ethanol drove a 16% increase in fertilizer carloadings in the first quarter.
Metals/Construction Revenue & Units
Metals and Construction products generated revenue of $274 million for the quarter, down 1% versus last year, in the face of an 11% decline in volume. This sector faced tough comparisons to first quarter 2006, as we reported record revenue and volume, with year-over-year gains of 25% and 12% respectively during this period last year.
During the first quarter, total U.S. steel production fell 11%, and we estimate that reduced steel demand from the automotive sector drove approximately 25% of the reduced orders and production.
Paper Revenue & Units
Paper and Forest Products revenue reached $211 million for the quarter, down $3 million, or 1% as volume fell 8%. Housing starts were off 30% in the first quarter which we believe led to the 20% reduction in our lumber shipments, while increased imported paper partially offset declines in the pulpboard and domestic paper shipments.
Chemicals Revenue & Units
Chemicals revenue in the quarter grew by 6% to $274 million, despite a 1% decline in volume associated with lower demand again driven by the housing and automotive sectors. Contract renegotiations and improved pricing drove the improvement in RPU and overall revenue growth.
Automotive Revenue & Units
And finally, Automotive revenue of $227 million was down $35 million, or 13% for the quarter, accompanied by a 14% decline in volume. Extensive production cuts at the Big 3, including the full impact of Ford and GM plant closures in 2006, drove the decline. Inbound auto parts to the affected plants declined by over 7,000 carloads which represented a third of the volume loss but close to half of the revenue decline in the quarter.
International auto volume grew 3% due to strong export shipments, as well as new Suzuki and Toyota traffic.
However, we expect the loss of over 12,000 carloads of auto parts for the balance of this year due to plant closures, and production cuts, which obviously will continue to pressure our year-over-year comparisons. This trend will continue into 2008 as the announced plant closures are completed. Auto parts traffic generates a higher than average revenue per car of $2,400, so the loss will have a disproportionate impact on RPU and revenues. This traffic will not generally be replaced as domestic auto production shifts closer to the Ohio Valley in close proximity to parts suppliers.
Automotive Industry Restructuring
This slide graphically depicts the magnitude and depth of the Big 3 restructuring plans. While I will not go through a deep dive of the details of these production cuts, suffice to say that our automotive year-over-year comparisons will be impacted in each quarter for the balance of this year and into 2008, and to lesser degree 2009, as GM’s plant in Atlanta and Chrysler’s plant in Newark, Delaware are shuttered in those years.
Intermodal Variance Analysis
Now turning to our Intermodal market, Intermodal revenue in the quarter was $462 million, down 1% versus 2006 as volume declined 1%, in the face of softer demand and higher truck capacity.
Revenue per unit gains moderated to 1% this quarter, compared to the strong growth we saw in the first three quarters of 2006. RPU growth was primarily driven by fuel surcharges and contract rate increases.
Domestic & Truckload
Within the market segments, combined truckload and domestic IMC volume decreased 3% for the quarter. Overall domestic IMC demand was lower due to higher truck capacity and softer pricing over the highways.
Truckload shipments, on the other hand, continued to grow with major customers such as J.B. Hunt.
Truckload volumes should remain strong and domestic IMC traffic should improve as truckload capacity trends downward as the year progresses. Also, during the second quarter, we expect to begin new domestic Intermodal train service from Los Angeles to Atlanta over the Meridian Speedway via Union Pacific -Shreveport. This new high speed route will reduce total rail mileage and provide the fastest available service to this market.
In the international segment, our volume was flat for the quarter as imports to the U.S. moderated. A 7% increase in our East Coast port volume was almost offset by a 6% decline in West Coast port volume.
Our West Coast port volumes are being challenged by higher inland transportation costs from western ports combined with the effects of recent steamship line consolidation. These two factors have resulted in market share shifts between ocean carriers, which in the short run is impacting our volumes. But on the positive side of the equation, we have recently secured two new transcontinental international commitments which should generate added West Coast volumes this year, and we expect our all water service business over the East Coast ports to continue to build.
Premium & Triple Crown
Finally, our premium Intermodal volume increased 6% while Triple Crown volume declined by the same percentage. Within the premium sector, we saw increased repositioning of revenue empties for UPS, which boosted overall volume and revenue, but at lower revenue per unit.
Triple Crown’s lower volume was the result of reduced automotive traffic in the face of plant closures and production cuts.
Looking Ahead – Intermodal and Coal
To summarize, we had difficult year-over-year comparisons in the first quarter and we will face similar comparisons in the second quarter versus 2006 volumes of over 2,000,000 shipments. Compared to first quarter 2007, we will need to handle an additional 153,000 loads to just match the record level set in the second quarter of last year.
In the short term, we expect the current weakness in housing and automotive will continue to impact volumes in most of our sectors. However, we are seeing signs of stronger demand ahead, and projections call for excess trucking capacity to diminish in the second half of the year. This, along with new international business, stronger truckload and premium volumes, and our new train service to Atlanta all bode well for renewed Intermodal growth.
In the energy sector, coal stockpiles have moderated in the face of severe winter weather which is an opportunity in our utility market going into the high demand summer season. And, the outlook for met coal is improving as two of our major customers restarted blast furnaces during the first quarter.
Looking Ahead – Merchandise, Automotive, Pricing
In Merchandise, Chemical volumes and revenues should improve as lower inventories of plastics are rebuilt and we gain new business through plant expansions and new business development activity. Ethanol volume will continue to build and increased shipments of fertilizer ingredients to boost corn production are expected which will generate higher revenues going forward. And, projected higher steel demand of 8% over the first quarter bodes well for increased volume in the sector.
Auto parts and automotive will continue to represent difficult comparisons as discussed today, but we expect our portfolio of “new domestic” plants to generate substantial new revenue to mitigate these losses as new production and expansions at Toyota, Honda, BMW, Mercedes and other manufacturers continue to build.
In short, we have a solid service network and a strong and balanced franchise. Near term softness as seen today will, in our view, transition to a renewed level of growth and market expansion as the year progresses, and our focus on market based pricing continues to present a clear opportunity for margin enhancement ahead.
Thank you, and now Jim Squires will review the details of our financial performance for the quarter.
Remarks by James A. Squires >>