BB&T Capital Markets Transportation Services Conference

[Anonymous]

BB&T Capital Markets Transportation Services Conference
Miami, FL - February 15, 2006

Prepared remarks by:

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

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

Good morning. It’s a pleasure to join you. I would like to thank John [Barnes] and the entire BB&T Capital Markets team for inviting us to participate in this new event.

I am joined this morning by Don Seale, our Executive Vice President for Sales and Marketing, and Leanne Marilley, our Director of Investor Relations.

What we would like to do first this morning is have Don Seale provide you with an in depth discussion of our 2005 railway operating revenues and provide a brief outlook for 2006.

Slide Good morning.

It is a pleasure to join you today. As you know, we are coming off of a record performance for 2005. So this morning I will recap some key trends in our business and our outlook for continued market expansion and yield improvement going forward.

Slide Before we look ahead, it’s worthwhile to review where we have been over the past five years compared to industrial production, the other U.S. railroads and the motor carrier industry.

Since 2001, our volume has increased at nearly twice the rate of these comparative metrics. Our units have grown 17% over 2001 levels, led by a 43% gain in Intermodal volume. This compares to 9% overall growth for the other U.S. railroads.

Our growth has also outpaced expansion in manufacturing by nearly a three-to-one ratio. The low tech industrial production index has increased 6% over the recession year of 2001.

And perhaps most importantly, our five year growth trend has exceeded the 9% gain in truck tonnage over this period.

Slide In 2005 we recorded volume of 7.8 million units as we faced the challenges of production cutbacks in the Automotive industry, storms in the Gulf Coast and suppressed coal availability for our export Coal market. Despite these challenges, total volume was up 4% over 2004.

Our Intermodal business grew 9% and accounted for 82% of volume gains.

Our Coal business grew 3% and exceeded the previous record volume year of 2001 by 2.4%.

Our industrial carload business grew 1.5% over 2004 and we continue to see encouraging signs. Agriculture and Metals/Construction reached record volumes in 2005, and more significantly, these groups exceeded the volumes of 2000, the recent height of the manufacturing cycle in the U.S.

Slide You may recall that one year ago we reported what we thought was tremendous revenue growth of $844 million over 2003. This certainly presented a seemingly difficult hurdle to clear in 2005, but we finished the year with $8.5 billion in operating revenue, an increase of $1.2 billion, or 17%.

To give you another perspective of the magnitude of this growth, our revenue gain in 2005 exceeded revenue growth for the period 2000-2004, and looking back over the past five years, total revenue is up 38% as volume expanded by 17%.

Slide For the past two years we have recorded revenue growth of over $2 billion, and nine consecutive quarters of reporting record revenues. During this time, each of our business sectors produced record revenues.

Coal revenue gains were led by increased utility carloadings in the face of high natural gas prices and rising electricity demand.

Intermodal gains moderated slightly versus 2004 growth, but were still up by 19%. Increased international traffic continues to lead growth in this sector.

Industrial Products recorded strong revenues for the year, despite some variability in volumes during the second half.

And our Automotive franchise produced a revenue increase of 5% despite production cuts and Ford and General Motors.

Slide Continued improvement in revenue per unit culminated in an all time high for all of our business groups, with total RPU increasing 12% over 2004. Rate increases, favorable changes in traffic mix and fuel surcharge coverage contributed to the gains.

As we all know, for the past two years in particular, the pricing environment has been much more favorable for rail transportation as a result of higher freight demand and constrained capacity in the truck market. Concurrently, our service product has improved as a result of our TOP and TOP 2 service plans. Network capacity and reliability have produced the opportunity to convert traffic from the highways, much of which has been gained in a collaborative fashion with the truckload carriers. These factors along with rising truck pricing in general continue to support improved pricing for our service.

Over the past year, we estimate that 50% of our book of business was renegotiated and re-priced and approximately the same percentage will be available in 2006. As part of our pricing strategy we are generally shortening the term of our contracts and deploying more effective escalators to ensure that pricing reflects current capacity and demand in the freight market place.

Slide Turning to our individual markets, we are bullish on our Coal franchise going forward. Electricity generation from Coal is forecasted to grow 9% in the next five years, and electricity generation in our service territory is projected to increase 2.5% in 2006 which bodes well for our utility market. In 2005, our utility coal volume grew by 4% while generation was up 3.6%. As you know natural gas prices have been at record highs, and nuclear power generation capacity has reached its maximum. Coal fired generation is the most economical alternative.

2006 is off to a good start for our utility market as volume is up 15% for the first 5 weeks of the year and we have seen production in Central and Northern Appalachian coal increase by 4.9% and 1.4% respectively.

Domestic metallurgical coal was up 8% in 2005 versus steel production which decreased by 5.8%. In January 2006, domestic metallurgical volume is up 12.6%.

The outlook for our export market for 2006 is more favorable. The steel inventory overhang in Europe continues to be worked off, and higher steel production has resumed. Consol’s Buchanan mine resumed operations in December and has an output of approximately 5 million tons of coal. Last of all, world hard coking coal supply will remain tight through 2006 which should translate into ongoing demand for U.S. coking coal in this market.

Slide Intermodal will continue to lead the volume growth on our system through 2006. In 1998, this sector accounted for 13% and now represents 21% of total revenue. The primary driver behind this sector’s success has been robust international trade which grew 7% in 2005.

The International component of our business grew to 47% of our overall Intermodal portfolio at the end of 2005.

Total U.S. import volume through West Coast ports increased by nearly 9% in 2005. China was the primary driver for this increase as U.S. imports from China surged in the 3rd quarter of 2005, and accounted for more than 50% of the container imports to the U.S. for the first time ever. The increase in container imports from China outpaced growth from all other regions, accounting for 80% of the total growth during the third quarter. In 2006, we expect this trend to continue as China is expected to add 10 times as much import freight to the U.S. than the rest of the world combined. NS volume handled through West Coast ports was up 13% in 2005.

Total all water service to East Coast ports grew 8.4% in 2005. Our East Coast volume was up 18% as more containers were being routed through Savannah, New York and Norfolk given the lower cost and more consistent service.

For 2006, the international shipping lines are projecting 10%-11% growth in container business, and we anticipate our total volumes to East Coast and West Coast ports to shift closer to a 50-50 split going forward.

Slide Investments in our network, terminals and infrastructure are supporting this growth along with higher demand in these lanes.

During the past five years, we have opened new terminals in Austell and Savannah, Georgia and Maple Heights, Ohio. Volumes in the lanes that utilize some or part of the Golden Triangle lines grew by 9.0%, which is roughly the same as our overall growth rate for 2005. Approximately 83% of our volumes ran on some portion of what we call our Intermodal Golden Triangle, which links Chicago, Harrisburg, Pennsylvania, and Atlanta.

Slide We continue to plan further capacity enhancements and have several planned terminal expansions over the next three years. Austell, Georgia, Chicago – 63rd street, Cleveland - Maple Heights, Croxton, New Jersey, Detroit - Livernois and Philadelphia Navy Yard expansions should be complete by the end of this year. We will also open a new terminal at Louisville -Appliance Park at the end of 2006.

In 2007 we will complete phase 2 of our expansion project at Cleveland - Maple Heights, and our Rickenbacker facility at Columbus, Ohio is scheduled to open.

Slide One of our largest projects is the Heartland Corridor, which will be a major capacity enhancement for our Intermodal business. We expect to complete this project over the next three years. The entire route linking the Port of Norfolk to Columbus, Ohio and Chicago will be cleared for double-stack train service by raising clearances at 28 tunnels in Virginia, West Virginia and Kentucky. New Intermodal terminals along the route are planned for Roanoke, Virginia, Pritchard, West Virginia and a mega-terminal at the Rickenbacker Air force Base in Columbus, Ohio.

When completed in 2009, this corridor will create a substantially more efficient route for existing traffic routed between Norfolk and Chicago via Knoxville or Harrisburg today. It will also foster new business at the newly completed terminals. The route itself will be 225 miles shorter than the existing clearance routes.

Slide Turning to our Automotive franchise, as mentioned in our Analyst presentation last month, we estimate a loss of about $35 million due to the recent announcements of closures and production cutbacks by Ford and General Motors.

The Ford plant closures represent action taken to rationalize their existing excess production capacity and market share changes. Our traffic mix change as a result of market share shifts between auto manufacturers has been largely realized. Of the five plants specifically announced for closure, we directly serve the St. Louis and Atlanta assembly plants and the Batavia transmission plant.

Total U.S. transplant production increased 13% in 2005, and production at the 10 NS-served international transplants has doubled over the last 10 years to 1.6 million vehicles annually. We expect that increased transplant production in 2006 will offset much of the Ford and GM losses. For example, our volume from Toyota’s new truck plant in San Antonio, Texas which should come online later this year will generate approximately 4,000 carloads of annualized additional business for our franchise. Additionally, recent assembly plant expansions by Toyota, Honda, BMW and Mercedes assembly plants served by NS will generate increased vehicle business for 2006 and ensuing years.

We remain positive about our Automotive franchise. In spite of the recent announcements, we are still the largest rail carrier of automotive parts and finished automobiles in North America. We have a broad base of automotive customers, and serve over 30 assembly plants of all major manufacturers and more than 70 auto parts suppliers which provide further opportunity for growth in our carload, Intermodal and Triple Crown Services.

Slide I will conclude my business group discussion with our industrial carload sector that has faced challenges of its own the past few years. Low tech industrial production is rebounding as the gulf area rebuilds.

Looking at our Chemicals sector, strong first half 2005 growth could not offset losses due to the hurricanes on the Gulf Coast. For 2006 we should see growth in our plastics sector as production is expected to increase 4.7% and North American Plastic operating rates will reach 94%.

Our Paper and Forest Products business completed its fourth consecutive year of growth in both revenue and volume after several years of mergers and production cutbacks. Our service attracted additional volume in a paper market that was mixed overall. We experienced a 52 week high loading period just before Christmas and the level of increase continues.

Our outlook for the Metals market remains positive for 2006, with moderate growth in consumption of steel mill products, and improvement in North American output. In 2006, domestic steel production is projected to increase 4.4% over 2005.

We also expect a stronger environment for our import steel slab business. We project higher volumes of import slabs for 2006 and plan to handle over 37 trains per month, or 460 for the entire year.

Diversions from the highway should also add to our business. Capacity is expected to remain tight for the flat bed trucking industry. This will keep upward pressure on truck rates which should bode well for further yield and growth in rail shipments.

Our Agriculture business continues to see increased demand from new feed mills in South Carolina, Georgia and Virginia. We now have 25 feed mills in place that take unit trains, ten-75-car unit receivers and fifteen - 50-car unit receivers, which represent ratable, year round volumes of grain from the Midwest to the Southeast. Through this combined Marketing-Industrial development effort over the past few years, we have essentially repositioned our participation in the grain market away from the variability of the export grain market.

Slide Shipments of ethanol also increased by 34% in 2005, adding to our Agricultural group’s performance. NS handles ethanol from 30 producers to 16 terminals located on our network. Additionally we serve five ethanol plants that are expanding in 2006 and have three new plants under development on our line. Over the next five years, ethanol consumption as a gasoline additive or supplement is expected to increase by 4 billion gallons to a total 7.4 billion gallons by 2011.

Slide The unfortunate disaster of Hurricane Katrina left many in the affected area without homes. As a result of our proactive efforts, FEMA immediately turned to NS for the movement of temporary housing trailers to the Gulf Coast area. Three weeks after the hurricane, NS moved the first unit train of trailers from Elkhart, IN to Selma, AL. Over the four month period that ensued, we handled 102 trains to Selma and the New Orleans area, approximately 6,700 carloads.

We are continuing to handle these trailers to the recovery areas and we are proactively planning with FEMA and other branches of the Federal Government to handle increased volumes of domestic relief goods, military shipments and related transportation needs.

Slide Turning to January’s performance, we already see positive signs for 2006. Our January loadings were up 9% over 2005 and 18% over 2004. We are still seeing some softness in Automotive and Chemicals, but expect Chemical’s shipments to increase over the next few months as Chemical plant operations on the Gulf Coast continue to recover and replenishment of inventories ramp up.

Coal, Metals/Construction, Intermodal, Paper and Agriculture all produced solid results for the month.

Slide In conclusion, we are well positioned to continue to handle healthy levels of business growth on our network in 2006. Our Coal and Intermodal markets are off to a strong start and we expect more of the same in the months ahead.

Our TOP2 operating plan is performing well and our improved service product will continue to provide upside pricing opportunities for the approximately half of our total business that will be renegotiated this year.

And finally, we see further opportunities in our Metals and Automotive franchises which remain the largest in the rail industry.

Thank you for the opportunity to participate in this year’s conference and now Hank will conclude with an overview of our expenses.

Slide Thank you, Don. Against a backdrop of record revenues and strong volumes, we are working hard to control our operating expenses and drive our operating ratio down, even in the face of some cost headwinds.

Slide This pie chart shows the various components of our operating expenses for 2005. As you can see, compensation and benefits is the largest component of our expenses, accounting for 39 percent of our expenses for the year. Materials, services and rents are the second largest category, comprising 28 percent of our total operating expenses. These cost centers combined represent more than two-thirds of our total operating expenses and continue to be the principle focus of our cost-saving initiatives going forward.

Slide Our railway operating expenses were $6.4 billion in 2005, which was $800 million, or 14 percent, higher than 2004.

Slide The largest increase was in diesel fuel expense, which rose $278 million, or 62 percent, reflecting record-high prices. Our diesel fuel expense would have been even higher but for the fact that we had hedged diesel fuel, which saved us $148 million in diesel fuel expense. Our hedges run out in May of this year, but at current prices will produce about $20 million more in expense savings. The important point here is that in the absence of more hedges we will face a $128 million diesel fuel expense headwind compared with last year.

Slide The second largest expense increase was in compensation and benefits, which increased $221 million, or 10 percent.

Slide The increase in compensation and benefits was driven by: 1) more T&E and mechanical hours that added $70 million; 2) higher wage rates that added $46 million; 3) increased benefits costs and lower pension income which totaled $43 million; 4) increased stock-based compensation of $22 million; 5) increased salaries and salaried headcount that totaled $20 million; 6) higher payroll taxes of $12 million; and 7) other miscellaneous items that collectively totaled $8 million.

Slide Materials, services and rents increased $208 million, or 13 percent, over 2004.

Slide This increase was due to: 1) higher volume related purchased services of $82 million; and 2) $74 million more that we spent on a variety of maintenance activities. In addition, equipment rents rose $28 million, due to our increased traffic volume.

Slide Depreciation expense increased by $176 million, or 29 percent, over last year, but as you can see on this slide, there was a corresponding reduction in Conrail rents and services that more than offset this increase in depreciation. The combination of this increase and decrease simply reflects the effect of the Conrail divisive reorganization in 2004.

Slide Casualties and other claims expense was $73 million, or 48 percent, higher in 2005 principally due to: 1) the costs associated with the Graniteville accident in the first quarter; 2) the unfavorable FELA personal injury verdict in the third quarter; and 3) the increased cost of casualty insurance, which rose over the course of the year.

Other expenses were up $34 million, or 15 percent, principally due to higher property taxes and sales and use taxes.

Slide With the 17 percent increase in railway operating revenues coupled with a 14 percent increase in railway operating expenses, we were able to reduce the railway operating ratio to 75.2 percent, a 1.5 percentage point improvement compared with 2004. This is our lowest operating ratio since the integration of Conrail.

Slide In 2005, we established a new record for income from railway operations. For the year, our income from railway operations increased by $415 million to $2.1 billion, a 24 percent improvement over 2004.

I should point out that the second, third and fourth quarters of 2005 represent the three highest quarters for operating income in our history. In fact, the last three quarters for 2005 produced more income from railway operations than all four quarters of 2004 combined.

Slide With record revenue growth and a strong economy, we have been able to generate record bottom line results. Our net income for 2005 was $1.2 billion, compared with $870 million (excluding a $96 million gain from the change in Ohio tax laws in 2005 and the $53 million gain on the Conrail reorganization in 2004).

A reconciliation of these amounts with our reported net income is available on our website at www.nscorp.com.

Slide On the same basis, our diluted earnings per share for 2005, were $2.88 compared to the $2.18 per share earned in 2004 (excluding the same two items: the Ohio tax legislation in 2005 and the Conrail reorganization in 2006).

Slide To put our most recent results into perspective, we have realized significant year-over-year improvements in our net income over the past five years. In 2005, our net income was a record $1.2 billion, an increase of 36 percent over 2004 and more than double the amount earned in 2003.

Slide The same pattern of improvement is reflected in our diluted earnings per share. Earnings per share for 2005 were a record high $2.88, which was 32 percent above the $2.18 per share earned in 2004 and again, more than double what we earned just two years ago, and three times what we earned four years ago.

Slide As our net income has grown we have generated increased cash flow and, as you can see, we have steadily reduced our outstanding debt over the past five years.

Slide This slide shows our debt-to-total capitalization ratio, which has been reduced over the last 5 years from 58.1 percent to 42.7 percent.

As a result of our reduction in outstanding debt, Standard & Poor’s raised our credit rating from BBB (flat) to BBT+ in July of last year.

Slide At the same time, we continue to make the investments necessary to keep our system in safe serviceable condition. Our 2005 capital expenditures were again just over $1 billion and we have budgeted $1.146 billion for additional capital spending in 2006.

With a generally robust economy and continued traffic growth, we are going to have to invest in some targeted investment in capacity. This investment will be made in some specific locations in order to accommodate growth and avoid traffic congestion. In addition, we will take delivery of 120 locomotives this year and we will continue to make the capital expenditures in our infrastructure that will enable us to improve our service performance even as we continue to grow the business.

Slide As you recall, we had to reduce our dividend in 2001 as we wrestled with the integration of Conrail. As our financial footing improved, our Board of Directors increased the company’s dividend in each of the last four years, and most recently increased it by another three cents per share, or 23 percent, in the first quarter of this year. In other words, the company has doubled the quarterly dividend in just two years.

Norfolk Southern has a long history of paying a regular dividend to our shareholders and this will continue to be a principal part of our overall financial strategy. Our goal is for Norfolk Southern to pay a dividend that is in line with the average dividend yield of the S&P 500.

Slide In summary, 2005 was an outstanding year for Norfolk Southern.

Railway operating revenues improved by 17 percent to a record high $8.5 billion.
Our railway operating ratio declined by 1.5 percentage points to 75.2 percent.
Income from railway operations rose by 24 percent and established a new record.
Net income increased by 36 percent to a new record high.
Earnings per share were up 32 percent and also established a new record.
And, the quarterly dividend was increased by 30 percent in 2005.
Simply stated – it was just a great year!

Slide We understand, quite clearly, that we have an obligation to continuously improve our performance in every aspect of our business in order to generate returns that are attractive for our shareholders.

In this environment of high energy costs and increasing highway congestion, Norfolk Southern and all of American’s railroads have a wonderful opportunity to participate in the renaissance of railroads. In order to be successful, we are going to have to provide our customers with service that is increasingly efficient and reliable. And the key to achieving improved customer service lies in a process of continuous improvement in everything we do.

That is where Norfolk Southern is headed - we are on track and moving in the right direction.

Thank you for your attention and we will take your questions at this time.

http://www.nscorp.com/nscorp/index.jsp

Dave
http://www.railpictures.net/showphotos.php?userid=920

[MP173]

Wow, they gotta be pretty upbeat about things right now.

ed

[SALfan]

Wish I had bought a load of their stock in 2000 or 2001.

[Anonymous]

I was lucky enough or smart enough
to buy it at $19.50 a share.

Today, NS stock closed at a 52 week
high of $50.77.

Dave
http://www.railpictures.net/showphotos.php?userid=920

[Anonymous]

QUOTE: Originally posted by dsktc

I was lucky enough or smart enough
to buy it at $19.50 a share.

Today, NS stock closed at a 52 week
high of $50.77.

Dave
http://www.railpictures.net/showphotos.php?userid=920

As did I - Great to smile every once in a while. PL

[MP173]

I never purchased NS, the high debt load scared me off. I personally thought they paid too much for Conrail, but as it turned out...CSX paid too much, or received too little.

NS is one tight railroad. I listen in on my scanner and am amazed at the tight schedules their trains keep.

My CN stock is thru the roof right now and I cant really figure out why. It is just about time for their stock to split once again. Luckily I got in on the IC stock back in the 90's and have ridden that for quite a ride. Green signals all the way.

ed

[bobwilcox]

My experience was on the revenue/customer side of the business. Looking at this part of this post they could not be in a better position for today's enviroment. Keeping contracts to no longer than one year is very, very important in 2006.

[daveklepper]

Thanks for the posting. It certainly is good news.

[nanaimo73]

QUOTE: Originally posted by MP173

My CN stock is thru the roof right now and I cant really figure out why. It is just about time for their stock to split once again. Luckily I got in on the IC stock back in the 90's and have ridden that for quite a ride. Green signals all the way.

ed

CN has an operating ratio of 61%, much better than anyone else. The Investment community likes Hunter Harrison a lot more than the employees do.
CN was the only class 1 with a higher average speed in 2005 over 2004, because they have extra capacity and do not have to invest in improvements as much as the other railroads have to.
http://www.canada.com/montrealgazette/news/business/story.html?id=b41fdf61-552c-47a9-b210-d1bdc9c9148d&k=96388

[bobwilcox]

CN is doing very well. I understand employess are upset as they remember the old Crown Corporation that was their Nanny and would make money next year. Oh will the world moves on.

The operating ratios of the CP and CN are not comparable with the US Class Is. The US railroads pay for their employess health insurance. We also have FELA which pays US railroad employess much more if they are hurt on the job.