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Financial Analysts’ Meeting
New York, NY - July 25, 2007
Questions and Answers(Question) Bill Greene, Morgan Stanley. On the locomotive fleet, the fact that you’re growing it, I would have thought that you would have had some excess given what’s happened with the volumes, so are there implications about how we should be thinking about 2008 cap ex from this? Are you trying to pull forward some spending to invest, given the opportunities you see in ’08? (Mr. Moorman) What I would say is, we clearly haven’t decided on the 2008 total capital budget for locomotives. Some of the 50 locomotives that we’ve received authorization for will, in fact, be delivered in the first quarter of 2008. The locomotives are largely aimed at new service plans that we’ve developed, which will greatly increase the velocity of our unit train network, both on the grain and the coal side. As you know, we’re looking at the prospect of buying a significant number of new coal cars over the next 7 or 8 years. We think these plans and this ability to increase our velocity will substantially reduce the requirements for new coal cars, and we’ll talk to you more about that as time goes by. But we think this is a very efficient use of capital to start reducing our equipment requirements today and in the future. (Question) Okay. And then can we just get a sense for two things. On pricing, in terms of just core pricing, how was it for the quarter, ex fuel and mix? And secondly, was the payroll tax benefit one time? (Mr. Moorman) The answer to the second question is the payroll tax benefit was a one-time item. But Don, why don’t you talk for a minute about pricing? (Mr. Seale) Bill, we continue to see pricing in line with what we saw in the first quarter. We saw 4 percent in the first quarter, another 4 percent in the second quarter. Mix, while it was modestly favorable, I’ll tell you it was only 0.3 percent, so essentially it was flat. The 4 percent RPU reflects the continuity in our pricing. (Question) Yes, good morning. It’s Tom Wadewitz. How should we think about intermodal sensitivity to the truckload market? If the truckload market remains weak for a sustained period of time, is it still possible to really see your intermodal volumes pick up, or is that a significant enough headwind that we really should pay attention to what that truckload market looks like when we think about your growth in intermodal? (Mr. Seale) Tom, as you know, the truckload market is comprised of a lot of different segments, and we’re seeing a portion of that truckload market, like our large asset-based participants, such as JB Hunt, continue to grow with us. We’re seeing others protect driver pools and actually take some freight and put it back on the highway, so we’re seeing a mixed bag. I think ahead, though, if we continue to see fuel prices go up – and the forward curve on oil indicates that that may happen – we’re optimistic that intermodal volumes on the truckload side will continue to improve. UPS is strong with us. JB Hunt continues to be strong. On the international side of the business, we do expect to see some semblance of a peak season this year compared to no peak last year. And as I mentioned, our comps on volume during the second half, compared to last year, are easier comps than the first half. (Question) On the international side, is East Coast business good or bad versus West Coast, and can you give me a sense of the difference in length of haul between those two? (Mr. Seale) About 50 percent of our international business is now East Coast. If you go back five years ago, it was only 20 percent. So, we have seen a migration of all water service where today we are about 50 percent off the West Coast and 50 percent off the East Coast. Hauls from one of the East Coast ports back into Ohio or back to Memphis are good hauls compared to the hauls that we have coming from the West. So we’re indifferent with respect to the East versus West. In that regard, we’re working with all parties from both coasts and all ports. (Question) Okay, great. One last one for Wick. How do we think about the speeding up the bulk network in terms of what that does? Do you go from three locomotives to four per train? Does your fuel consumption change a lot if you speed it up? And just what’s the logic behind that? Is it to address track constraints, or it’s just purely the car issue you’re talking about? I’m trying to understand the impact. (Mr. Moorman) It’s really not, on the expense side, an impact. You’re really hauling the same amount of tons the same distance, so the fuel requirements are the same. The crew requirements are largely the same. It really has to do with how we fit the unit train network into our already-scheduled TOP network, to increase the velocity by keeping power assigned in a different way – really almost allocating power to the unit train network and keeping it there, rather than trying to use power between the TOP network and the unit train network. But it is purely a play to increase the velocity of the equipment. It won’t have any other significant impact, other than we will be able to, and in fact are looking at in some cases, turning back leased equipment, particularly on the grain side, and being able to reduce in the future our, on the capital side, by not having to replace as many coal cars. But we want to get the improvement started right away. Let me say, the other really significant piece of this – and we’ve already seen this because we’ve started down this road already, particularly on the grain side – is as our velocities increase, our customers on the grain and the coal side are really seeing that improvement already and commenting very favorably on it, so it has a very strong service component as well. (Question) It’s Ken Hoexter. I like the new white background on the slides. After the years of the black background, it lets us take notes. Thank you. (Mr. Moorman) We listened to people’s comments about that. (Question) Just a quick follow-up on Tom’s question for Don. Is there a long-term benefit if these vessels are sailing east? In other words, what percentage now is kind of that port to inland, Ohio, Memphis, versus to now being really truck-competitive from the short-haul moves? (Mr. Moorman) That’s still somewhat in flux because we’re really seeing this shift happen and we’re trying to kind of understand it to some extent ourselves. It is clearly something where there are going to be some inland – or some East Coast containers – that move very short distances, whereas if they moved across the country it was a rail haul. But we think that is offset by the traffic that would be moving a very short distance from the middle of the country into the Midwest and is now a long haul. To give you an example of traffic that we think is good traffic that is absolutely booming, our Savannah to Atlanta intermodal traffic is skyrocketing. The Port of Savannah is having a lot of growth. We see that as good business, and we are running the train service and we intend to capture that business. So, it’s really a situation where I think the world is changing. The really important point I would make to you is that as business moves to the East Coast and to the biggest ports on the East Coast, in addition to the New York-New Jersey port, Norfolk, which is a great port and has seen just explosive growth and investment, and Savannah, Charleston, Jacksonville, the ports up and down the East Coast – if you look at our network and you look at the investments we’re making in that network, such as the Heartland Corridor, we think we are going to be extraordinarily well-positioned to capture that intermodal traffic that wants to move into the interior of the country, be it Atlanta, Columbus/Rickenbacker, Chicago or wherever. So we think that over the long term, this is going to be a good thing for us. (Question) Are you constrained near term by any need for, I guess, raising tunnels? (Mr. Moorman) Clearly the Heartland Corridor is the biggest project we have. We are looking at some – in fact we’ve authorized, I think, one reasonably small project on the Savannah side. We’ve added some sidings already on the line coming out of Charleston. So, we’re targeting infrastructure on a build-it-as-the-traffic-gets-there basis, and that’s part of our ongoing study to look at infrastructure across the company and add it selectively as we need it. (Question) Just a couple of quick technical ones. Was there any catch-up in the casualty line item? Are there any accruals that were made up in that line item? (Mr. Squires) Yes, we did have a favorable variance in PI as well as in derailment costs that I mentioned in the quarter, but that was not due to any actuarial adjustment. It was just the usual ups and downs in PI. So, nothing particularly significant there. (Question) Great performance then. Jim, while you’re up there, are you increasing the cap ex budget at all for these 50 locomotives or is it…? (Mr. Squires) Yes, there will be an addition to the capital budget for that purpose. (Question) In ’07? (Mr. Squires) Yes. (Question) You care to quantify that? (Mr. Squires) Sure. That’s going to be a $93 million addition to the capital budget, some of which will be actually be spent – (Mr. Moorman) Spent in ’08. (Mr. Squires) – $65 million of that will fall in ’07 and the rest will fall in ’08. (Mr. Moorman) One of the reasons, as well, that we looked at the locomotive side, talking about ’08, is we looked at when locomotives were going to be available in terms of production line scheduling and versus our needs. And in order to fit them into when we thought the traffic justified it, it made a lot of sense to get some space that remained in the fourth quarter on into the first quarter. Otherwise, we were looking at a significant time delay before we could get the locomotives. So, it was a timing issue, to some extent. (Question) So just to clarify, your net cap ex budget actually is going up – just because we’re seeing a lot of other companies in the transport sector as a whole actually reduce cap ex because of the negative volumes right now, but you’re actually net increase? (Mr. Squires) That’s correct. And that’s because we see financial benefit from making the investment, as Wick went through, especially with respect to unit train efficiencies. (Question) Okay. And then my last technical question is on your synthetic tax credits. You said you bought one and you’re buying another. Is there a cash outlay that you’re making for this, and is there a capital cost? (Mr. Squires) There is a relatively modest initial up-front investment coupled with ongoing operating costs for the duration of the year for those, yes. We’ve closed on one and we will be closing on the other in August, probably. And the net benefits you’ll see that we gave you today, and you’ll see further explanation in MD&A in our upcoming Q of the effects of these investments, so hopefully it will be relatively easy for you to follow and sensitize as we go through the year. (Question) Okay, can you quantify what you’re spending on these? (Mr. Squires) The expenses are as shown as projected in the slide. So, just to take a look at the slide – we gave it to you for the second half of the year, the additional expense. (Question) No, no, I mean there’s no cash outlay to acquire this? (Mr. Squires) There is. There is a cash outlay, yes. It’s included in the expense. (Question) Oh, in the expense. (Mr. Moorman) There’s no addition to cap ex. (Mr. Squires) In other words, Ken, no. In Other Income, that is, it’s all there. (Question) And just to clarify, do you want oil to go up or down to get that benefit? (Mr. Squires) To get the benefit from the synfuel investments? (Question) I think you said $71 was the base price. (Mr. Squires) Lower fuel prices are better from the standpoint of maximizing the net benefit from the synfuel investments. (Question) But each $1 that oil goes down you get that $3 million benefit. (Question) Correct. (Mr. Moorman) Down, but up to a maximum, which is, I guess you would compute it by – the current benefit is based on an 18 percent phase-out. So, if the phase-out went to zero, that would be the maximum benefit you would get. And we haven’t quantified that, but you could kind of back into that, I think, fairly easily. I mean, if oil goes to $20, we don’t get the benefit all the way, if that makes sense. (Question) (Unintelligible) Okay. And then my last question is just on the auto and housing. I just want to clarify – it was only 1.5 percent of 4.1 percent decrease in carloads? I was kind of surprised it was that light of a percentage on the reason for carload being down, I guess. More of a Don question. (Mr. Seale) Ken, we estimate that auto and housing was about 38 percent of the decline. (Question) 38 percent. (Mr. Seale) Yes. And compared to the first quarter, it was almost half of the decline, so we saw some diminished component in the second quarter, and we expect that to most likely continue to diminish as the comps change in the second half progresses. (Mr. Moorman) We do our very best in this analysis to try and figure out housing, and we do it on kind of a customer-by-customer basis because, as you saw, it cuts across a lot of our commodity groups. But, do we capture all of the inbound containers that had housing-related products in them that are now not being sold because of the downturn in housing? I’m not sure we capture it all. This is just our best attempt to figure out what those two sectors are doing, if that makes sense. (Question) Scott Flower, B of A Securities. Maybe some questions also for Don. You talked a little bit about a hope for peak, and I just wanted to get a little more color around how you’re manifesting that hope. Is it conversation with the customers, is it last year’s decline was so precipitous versus normal seasonality? Help me understand how much of this is just expecting normal seasonality versus dialog with your customers, or that you’re actually seeing things on the early side of peak that are making you more positive as you look toward third and fourth quarter on that front? (Mr. Seale) Scott, I would say that it’s a combination of what you just described. It’s conversations with the retailers, meetings with the retailers, but also a large part of it is exactly what you just stated was – the comps from last year. We saw our intermodal business start getting soft last October, which traditionally is the height of the peak season. We expect to do better than that this year, just based on what we see, the input we’ve gotten from retailers, and our own projections with respect to truckload, as well as international business. (Question) And then actually a couple more for you. You often told us that about a third of your business is touchable in any one year as a round figure. When we think about through the year, is it ratable, is it more skewed toward the early part of the year? Obviously it may change year by year, but how should I think about this year what you may have been able to touch versus sort of what is in the second half? (Mr. Seale) The timing of expiration of contracts and quotes, unfortunately is not ratable. It’s not a ratable process, and it is skewed, as you go through the year and you get a partial benefit, obviously, if you reprice something in December, you get the full benefit the following year but not in the current year. When we look at our coal business, a smaller percentage is being repriced this year. I think we shared that with you previously. On the Merchandise side of our business it’s about 45 percent to 50 percent. But it’s not a ratable quarter-to-quarter process. (Question) Has more of that for this year been touched in the first half, or will you see more open in the second half in general? (Mr. Seale) In terms of timing, we’re going to see more fourth quarter. (Question) And then the last question I had, where are you on fuel surcharge coverage in terms of proportion of your business, and did fuel surcharge – was it negligible in the quarter in terms of what it did up and down? That seems to be what most of the other railroads have been saying, but I just wanted to get – (Mr. Seale) It was negligible. Obviously with 82,000 less loads there was an impact from a revenue component there. Our coverage is around 93-94 percent. We feel we’ve gotten fuel coverage up to the point that it matches the available contracts and quotes. We are now waiting for contracts to turn over so that we can apply fuel, so it is a timing issue. (Question) Great, thanks. (Question) Wick, it’s Tony Hatch. I just wanted to ask two quick ones. Don, if you could just give a little more color on the pricing issues, specifically to intermodal, what we saw on the quarter and what you expect in those various categories? Wick, can you talk a little bit about what’s going on in Washington? It seems to be busier than ever these days and a lot of positive and negative things swirling around, and there’s still the UTU unsigned. Can you sum that up for us and see what we should be expecting this year and next year out of Capitol Hill? (Mr. Moorman) Let me try that and then Don will talk a little bit about intermodal pricing. As to what we might expect, my crystal ball is not particularly good, as you know, but there certainly is a lot of activity. There’s a lot of legislation that’s been proposed, particularly on the House side, that we think would have a detrimental effect to our industry. As you know, there’s – although people choose to call it things – there’s essentially a rereg bill that’s floating out there. There is another bill under the moniker of safety that has some things that we think are not good for our industry and don’t really have anything to do with safety, either. So there’s a lot of discussion about that legislation and a lot of activity. I think all of the rail carriers in the AAR are involved, and Norfolk Southern is certainly involved in that. I am an optimist in terms of thinking that ultimately reason prevails and the many, many people on Capitol Hill, on both sides of the aisle, who understand that a strong rail industry with the ability to invest and build infrastructure is one of the most important things that this country needs if we’re going to continue to grow and be competitive in the world marketplace. And, of course, relating to that, as you know, we have an investment tax credit proposal that’s starting to get some traction and I think will continue to get traction. And I’m not sure when it’ll get done, or if it’ll get done, but I’m optimistic about it. So, from that standpoint there’s a lot of activity, and we’ll just have to work hard to present our story and make sure that people understand the importance of our business. On the labor side, I guess the only thing I would say is, I think it’s – as you know, the TCU and the carmen have tentatively signed. They’ve signed the agreement, and it’s out for ratification. I guess we’ll know mid-September or thereabouts. That’s 80 percent of our work force that will be covered by an agreement, and 12 of the 13 unions. I think it’s a good agreement that everyone signed. I think it’s good for the industry. I think it’s good for the folks who work for our industry. And I’m very optimistic that ultimately the UTU will sign the same agreement. I’ve been puzzled, I will say, by some of their positions and their comments during this latest round of negotiations, but ultimately I think that this will be resolved, and hopefully resolved fairly quickly, because I think that’s the best thing for both the members of the UTU and for the rail industry. Don? (Mr. Seale) Tony, with respect to intermodal pricing, as you noted, the RPU was up 1 percent. We do not see a material change in our pricing philosophy with respect to intermodal. We have some activity on repricing in the second half, but it’s a small percentage of the total book of business. We continue to, as we renew contracts, update that portion of the contracts that I mentioned earlier that do not have fuel. We have a couple of remaining intermodal contracts which we’ll be working on, with modified fuel, bringing them to more of a standard fuel provision for us. But we’re not planning to take price and use it as a lever for additional volume. We’re going to maintain pricing of intermodal, and we think the value of our service speaks for itself, and with rising energy prices, we’ll fare well with that approach. (Mr. Moorman) Anyone else? Well, thanks for attending. You’ve been very patient, and we look forward to seeing you again. |
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