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

• Presentation Slides • Presentation Slides

• Reconciliation of Non-GAAP Performance Measures

Remarks by: • Wick Moorman • Donald W. Seale • Stephen C. Tobias • Questions and Answers

Remarks by:

Henry C. Wolf
Vice Chairman and Chief Financial Officer
Norfolk Southern Corporation

Good morning.  As Wick indicated, record railway operating revenues and income from railway operations produced record net income and earnings per share for 2006.

Railway operating revenues for the fourth quarter were $2.3 billion, up $62 million, or 3 percent, compared with last year. 

For the year, revenues were a record $9.4 billion, an increase of $880 million, or 10 percent.

Fourth quarter carloads were down 3 percent from last year while revenue per unit increased by 6 percent, yielding a 3 percent increase in revenues. 

For the year, volume increased 1 percent while revenue per unit rose by 9 percent resulting in the 10 percent increase in railway operating revenues.

Don Seale will provide you with the details of our railway operating revenues in just a moment.

Railway operating expenses for the fourth quarter were $1.7 billion, up $42 million, or 3 percent, compared with 2005.

For the year, railway operating expenses were $6.9 billion, $440 million, or 7 percent, higher than 2005.

The largest increase in operating expenses for the fourth quarter was in compensation and benefits, which rose $19 million, or 3 percent. 

This increase was primarily attributable to higher salaries and wages of $11 million; increased incentive and stock-based compensation of $8 million; and increased medical insurance costs for both active and retired employees which totaled $7 million.  These increases were offset in part by declines in other items, including lower life insurance and pension costs.

The next largest increase for the fourth quarter was in materials, services and rents, which rose $16 million, or 3 percent.

Materials expense increased $20 million during the quarter principally due to increased maintenance activities.  Purchased services were up only $2 million and equipment rents declined $6 million for the quarter reflecting lower traffic volumes.

Casualties and other claims were up $5 million, or 11 percent, higher than 2005, largely a result of higher expenses related to derailments. 

Other operating expenses rose $3 million, or 5 percent, compared to last year primarily due to increased sales and use taxes.

Diesel fuel expense for the quarter increased $3 million, or 1 percent, over 2005. 

As you may recall, our fuel hedging program wound down in the second quarter of 2006, and no new hedges have been put in place since that time.

The absence of any hedge benefits, which reduced fourth quarter 2005 expenses by $28 million, was almost entirely offset by a 10 percent drop in the average price per gallon which reduced diesel fuel costs by $25 million.

Depreciation expense was down $5 million, or 3 percent.  As you will recall, last year we conducted a required periodic depreciation study that was completed in the first quarter of 2006, which indicated longer depreciable lives for some of our assets.

For the full year, railway operating expenses were up $440 million, or 7 percent.  The largest increase in expenses for the year was in diesel fuel expense, up $250 million, or 34 percent.

This $250 million increase was largely due to $129 million less in fuel hedging benefits; and higher prices, which increased diesel fuel costs by $113 million.  A modest increase in consumption added another $8 million in fuel costs.

The next largest increase in operating expense for the year was in compensation and benefits expense which rose by $144 million, or 6 percent.

As you will recall, we implemented SFAS 123(R) on January 1, 2006, and our expenses include $36 million related to this change in accounting. 

In addition to the effects of SFAS 123(R), the increase includes:

• $44 million of higher salaries and wages,
• $29 million for increased medical insurance costs,         
• $17 million of higher payroll taxes,
• $13 million related to retirement agreements and waiver agreements with two former executives in the first quarter, and
• $11 million for the cost of the regular annual stock-based grant to the former Chief Executive Officer who retired in the first quarter.

Other miscellaneous items reduced these increases by $6 million.

I would also like to remind you that under SFAS 123(R) we are required to expense stock-based compensation grants to employees.  In addition, we are required to front-load the expensing for stock-based grants made to employees who are retirement eligible.  Stock-based compensation granted to employees who are not eligible for retirement are expensed on a quarterly basis over the vesting period.

 Norfolk Southern has historically made stock-based compensation awards in the first quarter of the year.  Therefore, an expense will be recorded in the first quarter of 2007 to reflect the grant of stock based compensation for the current year.  Although we won’t know the exact amount until we know the stock price at the end of March, we expect first quarter stock-based compensation expense, including the front-end loading, to be about 10 cents per share.  This reflects an increasing number of employees who will be retirement eligible in 2007 rather than a change in the level of grants made.

Materials, services and rents expense were up $86 million, or 5 percent, over last year.

Materials costs rose $39 million, reflecting increased maintenance activities and purchased services expense was also $39 million higher due to increased traffic volume earlier in the year.  Equipment rents were up $8 million, also primarily due to increased volume earlier in the year.

The largest decline in expenses was in depreciation which decreased $36 million, or 5 percent, a result of the depreciation study that was completed in the first quarter of 2006.

Casualties and other claims expense was $4 million, or 2 percent lower than last year; and Conrail Rents and Services were $3 million lower than 2005. 

The railway operating ratio for the fourth quarter was 73.5 percent, compared with a ratio of 73.7 percent in the fourth quarter of 2005. 

For the year, the operating ratio was 72.8 percent compared with 75.2 last year.  This represents our lowest operating ratio since the Conrail merger, and our third lowest operating ratio in the history of Norfolk Southern.

Fourth quarter income from railway operations was $614 million, up $20 million, or 3 percent, over the $594 million produced last year. 

For the year, income from railway operations was a record at $2.6 billion, up $440 million, or 21 percent.

Total other income and expense for the quarter was an expense of $75 million, compared with an expense of $90 million in 2005. 

Gains on sales of property and investments were $10 million below 2005, which included the sale of a large parcel in the fourth quarter. 

Returns from corporate-owned life insurance were $8 million higher than last year, principally due to improved stock market performance.

Expenses related to our synfuel investments were $6 million lower this year, reflecting the expected phase-out of a portion of the Section 29 tax credits. 
All other was an increase of $5 million.

Interest expense on debt for the quarter was $6 million lower than last year, largely due to less outstanding debt.

As you will recall, I spoke last time about the volatility associated with the synthetic fuel investments.  For the fourth quarter, average oil prices were quite close to the average price that we expected at the beginning of the quarter.  Accordingly, the forward curve proved to be correct and we indeed had a 35 percent phase-out for the year, which resulted in a net benefit in the fourth quarter of about $7 million and $18 million for the full year.

For the year, total other income and expense was an expense of $327 million compared with an expense of $420 million in 2005. 

Expenses related to our synfuel investments were $39 million lower than last year, reflecting the phase-out of the Section 29 tax credits.

Interest income increased $35 million as a result of higher cash balances and interest rates.

  Returns from corporate-owned life insurance rose $20 million over last year primarily due to improved market performance for invested assets.

Equity in Conrail earnings were $12 million lower and other miscellaneous items decreased $7 million from last year.

Interest expense on debt for the year was $18 million lower than last year, largely due to less outstanding debt.

Income Before Income Taxes

Fourth quarter income before taxes was $539 million, compared with $504 million, a 7 percent increase. 
For the year, income before taxes was $2.2 billion, up $533 million, or 31 percent, compared with $1.7 billion last year.

The provision for income taxes for the fourth quarter was $154 million compared with $142 million last year.  The effective tax rate was 28.6 percent, compared with 28.2 percent last year. 

For the year, the provision for income taxes was $749 million, compared with $416 million in 2005.  You will remember that 2005 was positively impacted by a $96 million non-cash tax benefit associated with changes in Ohio tax laws.  The effective rate this year was 33.6 percent, compared with 24.5 percent in 2005.  The Ohio tax law change reduced the 2005 effective rate by almost 6 percentage points.  Most of the rest of the 2006 increase in the effective rate was the result of the reduced Section 29 tax credits this year. 

Fourth quarter net income was $385 million, up 6 percent compared with the $362 million earned last year.

For the year, net income was a record $1.5 billion compared with $1.3 billion last year, an increase of $200 million, or 16 percent.

Diluted earnings per share for the fourth quarter were 95 cents, up 9 percent, compared with 87 cents per share earned last year.

For the year, diluted earnings per share were a record $3.57, which was 15 percent above the $3.11 per share reported a year ago.

Last year I provided you with a comparison of our net income and earnings per share excluding the effects of the change in Ohio tax laws.  On that same basis, this year’s net income for the year of $1.5 billion would have been $296 million, or 25 percent, higher than 2005. 

Similarly, our diluted earnings per share of $3.57 would have been 24 percent higher than the $2.88 per share earned last year excluding the Ohio tax law change.

This slide reconciles the net income and earnings per share for 2005 excluding the impact of the Ohio tax legislation to our reported net income and earnings per share. This reconciliation is posted on our web site for your reference.

Thank you for your attention and now I’ll turn the program over to Don Seale, who will give you an in‑depth report on our revenues.

Remarks by Donald W. Seale >>