Oct 24, 2007
Executives
Leanne Marilley - Director of Investor Relations Charles Moorman - Chairman, President and Chief ExecutiveOfficer Stephen Tobias – Vice Chairman and Chief Operating Officer James Squires - Executive Vice President Finance and ChiefFinancial Officer Robert Kessler - Vice President of Taxation William Romig - Vice President and Treasurer Donald Seale - Executive Vice President and Chief MarketingOfficer Marta Stewart - Vice President and Controller
Analysts
Tom Wadewitz - JP Morgan Chase William Greene - Morgan Stanley Ken Hoexter - Merrill Lynch Jason Seidl - Credit Suisse Scott Flower - Banc of AmericaSecurities Edward Wolfe - Bear Stearns David Feinberg - Goldman Sachs John Larkin - Stifel Nicolaus John Barnes - BB&T Capital Markets
Operator
Greetings and welcome to the Norfolk Southern CorporationThird Quarter Earnings Conference Call. At this time all participants are in alisten-only mode.
A brief question-and-answer session will follow the formalpresentation (Operator Instructions). As a reminder, this conference is being recorded.
It is nowmy pleasure to introduce your host, NorfolkSouthern's Director of Investor Relations, Leanne Marilley.
Leanne Marilley
Thank you, and good morning. Before we begin today's call Iwould like to mention a few items.
First, we would like to welcome to you ourthird quarter conference call. We remind our listeners and Internet participantsthat the slides of presenters are available for your convenience on our websiteat nscorp.com in the investor section.
Additionally, MP3 downloads of today's meeting will beavailable on our website for your convenience. As usual, transcripts of themeeting also will be posted on our website and will be available upon requestfrom our corporate communications department.
At the end of the prepared portion of today's call, we willconduct a question-and-answer session. At that time, if you choose to ask aquestion, an operator will instruct you how to do so from your telephone keypad.
Please be advised that any forward-looking statements madeduring the course of this presentation represent our best good faith judgmentas to what may occur in the future. Statements that are forward-looking can beidentified by use of the words such as believe, expect, anticipate, andproject.
Our actual results may differ materially from thoseprojected and will be subject to a number of risks and uncertainties, some ofwhich may be outside of our control. Please refer to our annual and quarterlyreports filed with the SEC for discussions of those risks and uncertainties weview as most important.
Additionally, keep in mind that all references to reportedresults excluding certain adjustments, for example, non-GAAP numbers, have beenreconciled on our website. Now, it is my pleasure to introduce NorfolkSouthern's Chairman, President and CEO, Charles (Wick) Moorman.
Charles Moorman
Thank you, Leanne and good morning. It is my privilege towelcome you to our Third Quarter 2007 Analyst Conference Call.
As part of ourinitiative to enhance communications with you, we are reporting today's resultsvia teleconference. This format will provide the opportunity for many listenersto ask questions at the end of the prepared portion of today's call, timepermitting.
As always, we value your thoughts and opinions on how best to shareour results with you, so please let us know what you think of today's call. We have with us today several members of our managementteam, including our Vice Chairman and Chief Operating Officer, Stephen Tobias;along with Donald Seale, our Executive Vice President and Chief Marketing Officer;and James Squires, Executive Vice President Finance and Chief FinancialOfficer.
We are also joined by Robert Kessler, our Vice President of Taxation; WilliamRomig, Vice President and Treasurer, and Marta Stewart our Vice President andController. Norfolk Southern's Vice President Corporate CommunicationsBob Fort, whom many of you know and has been a familiar presence at theseevents, retired in August after 30 years of service to our company and I knowthat you join us in wishing him the very best in retirement.
Turning to the third quarter, I'm pleased to report that NorfolkSouthern continued to deliver solid results, reflecting the strength of themarket for our transportation products as well as our sustained focus on providinga higher value service product. Softness in certain segments in the economy resulted inreduced traffic volumes, which we were substantially able to offset throughpricing gains and cost controls.
We remain confident in the overall strength ofour franchise, and we continue to take a long-term perspective as we plan newtraffic corridors, improve technology, and support our work force with thetools necessary to provide superior service. Despite fewer intermodal and coal shipments as well as continuedweakness in the housing sector of the economy, we produced improvement inrevenue yield and total revenue was only slightly below last year's recordlevel.
We were also able to control operating costs where appropriate given thebusiness environment. The result was net income of $386 million, or $0.97 dilutedearnings per share for the quarter.
And as you know, this includes the effectsof Illinois tax legislationenacted during the third quarter that reduced net income by $19 million, or$0.05 per diluted share. James Squires will provide you with the full detailsof our financial results in just a moment.
Operationally, we continue to safely and reliably handlewhat are still strong business demands. We also continue to improve our serviceperformance by strategically investing in the network and carefully managingall of our assets.
I will have a little more to say about our service metricsfor the quarter later, and Stephen Tobias is also ready to answer your questionsand provide commentary on our service initiatives. We also remain focused on our long-term growth initiatives.Work commenced in this quarter on the tunnel clearances on the Heartland Corridorand we remain on schedule to complete this initiative in 2010.
Additionally, construction continues on our Rickenbacker Global Logistics Park in Columbus, Ohio, with operations set to begin in early2008. We have a number of other new service initiatives in the works for nextyear as well, which we'll be telling you more about as they develop.
I'm now going to turn the program over to Donald Seale, whowill walk you through our third quarter results from a revenue and trafficperspective. James Squires will follow with the financial overview.
And then Iwill return with some closing comments before we take your questions.
Donald Seale
Thank you and good morning. A year-long cycle of a weakeneddomestic economy that began in August 2006 continues to impact freighttransportation demand.
During the third quarter, manufacturers appeared to slowproduction and in September the ISM Index fell to 52. While a number above 50 still represents modest expansion,September marked the third consecutive decline in the index, which is at itslowest since March.
As shown in the next slide, the sluggish domestic economyand changing international trade patterns resulted in total volume in thequarter of 1,909,000 units, a reduction of nearly 82,000 units or 4% below lastyear. Volume declined in five of our seven business groups.
The weak housing market continues impact our volumes andaccounted for the majority of the short fall. Excess trucking capacity and highcoal stockpiles accounted for most of the remaining loss but lower volumes ofimports also came into play.
This slide highlights the changing nature of imports andexports in the quarter as the dollar continued to weaken. Total import volumedeclined by 7%, while export traffic grew by 14%, as export growth exceededimport declines by some 8,000 loads.
With lower volume, total revenue as outlined in the nextslide reached $2.353 billion, down $40 million below the record revenue of$2.393 billion in the third quarter of 2006. Weaker volumes were partiallyoffset by record revenues in our agricultural sector, growth in chemicalsrevenue, and continued improvements in pricing across most of our businesssegments.
Accordingly, as noted in slide six, revenue per unit reachedan all-time high of $1,232, an increase of $30, or 2.5%, over third quarter2006. This was our 20th consecutive quarter of RPU growth.
Traffic mix impacted revenue per unit growth as volumedeclines in some higher-rated commodities, such as utility coal, iron andsteel, lumber and automotive parts traffic, were offset by growth in lower-ratedriver coal traffic, aggregates and municipal solid waste. However, the pricing environment remains favorable and rateincreases across our markets generally offset the effect of shorter haultraffic.
And as reported in the second quarter, the timing of re-pricing ofcontracts and rates, particularly in coal and intermodal suppressed RPU for thethird quarter. Now, turning to our individual business sectors, merchandiserevenue of $1.291 billion grew $8 million over third quarter 2006, despite a 3%decline in volume, due to lower shipments of iron and steel, and forestproducts.
This was the 15th consecutive quarter of year-over-yearmerchandise revenue per car growth, which was a record at $1,866 per car. Ourpaper, chemicals and automotive groups recorded all-time highs in RPU, and eachof our merchandise groups benefited from improved pricing during the quarter.
In slide eight, you will note that our agriculture group seta record for both revenue and volume in the quarter. Revenue of $264 millionwas up $25 million, or 10% over third quarter last year, while volume grew 2%.
Wheat volumes were higher due to increased export shipmentsas a weak international crop in Australia,Egypt, andother international regions prompted a spike in demand from U.S.producers. Also our integrated AgriFuels market, which includes biodiesel,ethanol, corn for ethanol production, dried distiller’s grain or DDG, soybeanmeal and fertilizers grew by 1500 carloads in the quarter.
Turning to automotive, revenue reached $221 million for thequarter, up $10 million, or 5% compared to third quarter 2006, accompanied by a4% increase in volume. Easier comparisons for the third quarter 2006, whichincluded 46 to 47 weeks of downtime, versus 26 weeks this year, led to thefirst year-over-year of volume gain in automotive since the second quarter of2004.
As you can see in the next slide, North American automotiveproduction increased 2% over the same period in 2006. Our new domestics volumerose by 6% during the quarter, while the Detroit3 volume, improved by 3%.
New business and finished vehicles and parts added toour favorable results in the quarter. With respect to the other three merchandise sectors, asshown in slide 11, chemicals, paper, and metals and construction continued tofeel the adverse impact of the housing market, along with slower consumerspending and reduced imports.
Despite these head winds, chemicals recorded its 17thconsecutive quarter of year-over-year revenue gains; chemical revenue reached$297 million, up $11 million or 4%, over third quarter 2006, while volume wasdown 1% due primarily to weaker plastics traffic. Revenues for paper and forest products, along with metalsand construction materials, declined 4%, and 9% respectively, as volumedeclines offset 4% RPU gain in paper, while adverse mix in metals andconstruction coupled with weaker demand drove revenues lower.
For example,higher RPU imported steel slab traffic was down 4500 cars in the quarter, andlower RPU aggregates traffic was up 3%, or 2500 cars. Now turning to our intermodal market, revenue in the quarterof $484 million was down 6% versus 2006 as volume declined 6% as well.
Revenueper unit fell slightly for the quarter as contractual and general rateincreases were offset by very strong East Coast short-haul growth in August andSeptember. In addition, the 24% decline in higher RPU trailer traffic continuedto impact overall RPU.
As depicted in the truckload freight index, in the next slide,one of the major drivers shaping current intermodal volumes continues to be theavailability of excess trucking capacity. Truckload volumes have declined andthe latest index is below 2002 and approaching the recession year of 2001.
Thetrucking industry has been negatively impacted by softer imports, and higherconsumer products inventories. And ample capacity in the spot truckload markethas ushered in another soft peak season this year.
Within our intermodal market segments, international volumewas down 5% for the quarter. Declines were driven by softer consumer demand andresulting import weakness, as well as some ocean carriers' ongoing reduction ofinland transportation services and changes in vessel port of calls.
Our East Coast port volumes grew 16%, while West Coast portvolume fell 17%, as shifts in business between ocean carriers and a generaldecline in transcontinental imports impacted our total intermodal volume. In the combined truckload and domestic IMC segments, volumedecreased 9% for the quarter.
Domestic IMC traffic loss reflected economicsoftness, and increased over-the-road truck competition. Truckload shipments were also down for the quarter, dueprimarily to a loss of business from some asset-based carriers.
These losseswere somewhat mitigated by over-the-road traffic conversions in our local NorfolkSouthern markets. Premium intermodal volume declined 3%, as increased parcelvolume did not fully offset soft LTL traffic.
And finally, Triple Crown volumedecreased 1% versus 2006, primarily due to excess trucking capacity. Now, turning to coal, looking at our coal markets, coalrevenue was $578 million, down $17 million or 3% below third quarter last year,accompanied by a 2% decline in volume.
Revenue per car was down 1%, as higherrevenue per car long haul volume decreased 5%, and lower revenue per car shorthaul volume increased by 7%. Let me give you an example.
One of our large short haulmovements to the Ohio River equates to only 26-milehaul, and the volume in this corridor was up over 21% in the quarter. Conversely,long haul utility coal from Central App to the Southeast was down 10% in thequarter.
These two movements, which are at opposite extremes in length of haul,represent a per car differential of over $1900. Now, turning to our individual markets in coal, electricutilities ended the third quarter with record demand for power.
Cooling demandextended well into September and continued into October for the NS-servedsouthern states. For the quarter, electricity generation in our service areawas up 4% over the same period last year, while coal-fired generation increasedby 2%.
High utility stockpiles were able to meet this increased demand forcoal, which is reflected in our 4% decline in utility coal volume in thequarter. In addition, Chesapeake Energy switched earlier this yearfrom domestic to all-water imported coal, at its Chesapeake, Virginia plant andcontinues to negatively impact year-over-year volume, revenue, and revenue percar comparisons.
Higher export coal movements more than offset declines indomestic metallurgical coal, coke and iron ore. In the third quarter, exportvolume was up 12,000 cars or 44%, while domestic metallurgical coke and ironore was down 7400 cars or 13%.
Export continued to benefit from Australian port congestionand the devalued dollar. Domestic met coal, coke and iron ore continued to bechallenged by weak market conditions, which have led to the closure of cokebatteries and the loss of 2006 spot iron ore shipments.
Cottages at the Buchanan and Pinnacle Creek mines and theclosure of Citizens Gas coke plant in Indianapolisin July also reduced metallurgical coal shipments. Finally, industrial coalcarloads were up 1% in the third quarter.
New business and stronger demand weretheir primary factors that drove growth in this market. Now looking ahead, increased global demand for coal and thelow U.S.
dollar will continue to bolster export markets for U.S.coals. On the other hand, demand for domestic met coal remains less vibrant dueto lower U.S.steel production, which may continue into early 2008.
Finally, as previouslystated we expect both the Buchanan and Pinnacle Creek mines to resumeproduction, which will enhance coal supply on NS going forward. In the longer term, replacing coal sources in the coalfieldsis an important part of our market strategy as production and coal supplyreflect the changing reserve base.
We are working on numerous coal sourcingprojects that will add new coal volume in our network. Among these highlighted here are four new coal-sourcingprojects that could generate a minimum of 6 million tons per year of additionalcoal volume starting in 2008.
Of these four projects, two are in Central Appand two are in Northern Appalachia. Next slide in our merchandise markets, there is significantproject and industrial development growth planned ahead.
New cement terminalsare being developed on NorfolkSouthern in Georgiaand South Carolina. Our scrubber stone network is poised for continued growth,driven by NS access to high calcium limestone quarries and coal-served utilityplants.
There are an additional 40 utilities who have announced plans to beginscrubbing in the near future. Also, ThyssenKrupp will break ground on its new $3.7 billionsteel plant in Mount Vernon, Alabamaon November 2.
This new mega mill should be a major source of new steel-relatedbusiness as it ramps up in 2010. As described in the next slide, we also expect to seecontinued gains in our ethanol markets, as new plants ramp up, and several newdistribution terminals open early next year.
These include terminals in New Jersey and Georgia. And finally, we're excited about the continuing improvementsin car utilization and customer service that we're seeing from our new 75-cargrain trains, which move with dedicated locomotives.
This service has improvedcar turns by almost 50%. In turn, shippers and receivers are developing originand destination facilities for rapid loading and unloading to take fulladvantage of this improved product.
And in intermodal, despite soft volumes in the quarter, weremain committed to continuing improvements and service and launching newproducts for our customers. During the quarter, we launched the westbound BlueStreak service over Shreveport, Louisiana,which reduces transit times and offers a service guarantee.
We also begin a newSavannah domestic intermodalservice to tap growing shipments of import freight in 53-foot equipment out ofthe Savannah market. Our intermodal service during the quarter improved by 7%versus the first six months of the year, and all-time performance was up 13%versus third quarter of 2006.
Our guaranteed service over the Meridian Speedwayis performing at 95% on time. In short, we're well positioned to convert motorcarrier traffic as the market improves.
Now, to summarize, slower economic conditions across much ofour business during the third quarter impacted both volumes and revenue. We do not foresee a materially different outlook through thefourth quarter, and in the early 2008, as industrial production, a weak housingsector, and excess trucking supply are not expected to improve in thenear-term.
Taking the longer view, however, we fully expect demand forour services to again build as the domestic and global economies expand. We arecontinuing our clear focus on improving yield and designing new services andproducts to fully meet the needs of our customers, while generating theappropriate value to our shareholders.
Thank you. And I will now turn the microphone over to JamesSquires for the financial report.
James Squires Thank you, Don. I’ll now provide a review of our overallfinancial results for the third quarter.
Net income for the quarter was $386million, a decrease of $30 million or 7% compared with the $416 million earnedin the third quarter last year. Diluted earnings per share for the quarter were $0.97, whichwas $0.05 per share, or 5% less than last year.
The decreases in both netincome and earnings per share reflect the impact of Illinoistax legislation enacted during the third quarter, which was $19 million or$0.05 per diluted share shown in yellow. Excluding that item, diluted earningsper share would have been $1.02, even with last year.
Let’s start with an overview of our operating results. AsDon described, railway operating revenues declined $40 million or 2%.
Thisresulted in a $34 million or 5% decrease in income from railway operations asoperating expenses declined by $6 million. The railway operating ratio rose 1percentage point from the record low of 70.1% in the third quarter of 2006.
Before reviewing the operating expenses, let me comment onshort-term cost controls. While our cost structure does have a large fixedcomponent, there are of course costs we can vary in the short-term.
We divide these into two categories: those linked to currentbusiness levels and those that affect our ability to capture futureopportunities. Norfolk Southern’slong-term prospects dictate our approach to costs associated with futureopportunities.
In spite of the current volume softness, we believe demandfor rail transportation will grow. Therefore, as shown on the right side of theslide, we have continued to spend prudently on maintenance.
A well-maintainednetwork, in addition to enhancing service, allows us to attract and retainfuture business. Moreover a stable pattern of spending minimizes outlays in thelong run.
At the same time, current volume conditions have allowed us to cutspending in the areas shown on the left side. Now, let's look at the expenses in detail.
The largestreduction was in casualties and other claims, which declined $17 million. Thisdecrease is largely due to favorable personal injury and lading claimsdevelopment, demonstrating the impact of our employees continued commitment tosafety.
In addition, the quarter benefited from an environmental insurancesettlement. Compensation and benefits decreased $5 million, or 1%, inthe third quarter compared with last year.
This is a modest change, but thereare a few moving parts I’d like to point out. First, stock-based compensationrose $15 million in the quarter, due entirely to last year's $9.17 per sharequarterly stock price decline.
Next, the accrual for incentive compensation decreased $10million, reflecting the higher bar set for our bonus calculation. And finally,there was a $10 million decrease from lower volume related payroll costs.
This is one example of variable costs that we try tocarefully manage by watching our payroll hours in the areas directly affectedby traffic volumes such as train crews, while not pulling back on hours in ourmaintenance areas. This is not to say the plans can't be modified.
They can, butalways with a longer-term view. Turning to the expense increases, diesel fuel expense roseby $1 million.
Here again, you can see our focus on the part of the costequation that is controllable. Fuel consumption was down $13 million,reflecting a 5% drop in gallons used that exceeded the 4% traffic volumedecline.
This largely mitigated higher fuel prices, which rose $14 million inthe quarter. Material services and rents increased $3 million, or 1% inthe third quarter compared with last year, as lower volume related equipmentrents partially offset higher maintenance costs.
A strong focus on assetutilization enabled an 8% decline in equipment rents. Other operating expenses increased by $4 million or 7%,primarily due to higher property, sales and use and franchise taxes.
Andfinally, depreciation expense increased by $8 million or 4%, reflectingcontinuing investment in our net worth and equipment. Now, let's turn to our non-operating items.
Other income netfor the quarter was $31 million compared with $41 million last year, a declineof $10 million. Gains on sales of property and investments rose $14 millionthis quarter.
As you know, the timing of these sales is somewhat unpredictable,but year-to-date, we are about even with 2006. Interest income decreased $11 million as a result of thelower cash balances and returns from corporate owned life insurance declined $8million.
Interest expense on debt was $13 million lower than last year, largelydue to less outstanding debt. Now, I would like to provide some detail concerning oursynthetic fuel investments.
The next slide shows amounts recognized during thethird quarter related to our synthetic fuel investments, which have a pre-taxand an after-tax component. As of the end of the third quarter, the tax creditphase-out was expected to be 43%.
The net benefit from these investments in the third quarterwas $7 million. This was $11 million less than we projected three months ago,due entirely to the rise in oil prices during the quarter.
Turning to the next slide, assuming the same 43% phase-outthat was projected as of quarter end, oursynthetic fuel investments would result in a total net benefit of $16 millionfor the remainder of 2007 compared with $7 million in the fourth quarter of2006. That 43% phase-out equates to a Nymex per-barrel average price for thelast three months of the year of about $81.
Of course, as oil prices have risen significantly, sincequarter end. Each dollar variability in the $81 average price affects the netbenefit by almost $2 million.
For example, should the average price for thefourth quarter approach $90 per-barrel, our net benefit for the quarter wouldbe zero. Turning back to our results, third quarter income beforeincome taxes declined 5%, reflective of the lower traffic volumes.
Income taxesfor the third quarter were $219 million compared with $220 million last year. The effective tax rate of 36.2% compared with a rate of34.6% in 2006.
The increase resulted from expenses associated with recentlyenacted Illinois tax legislation,which increased deferred taxes by $19 million. For the full year, assuming a43% synthetic fuel tax credit phase-out, the effective tax rate will be around34%.
I want to reiterate that this is affected by changes in oilprices. For example, if the average oil price for the fourth quarter is $90 abarrel, our full year effective tax rate will be 35%.
And now, I will update you on our share repurchase program.The next slide shows quarterly purchases since the inception of our currentprogram. During the third quarter of 2007, we bought back 6.7 million shares ofstock, at a cost of $341 million.
In total, we’ve purchased and retired 36.9 million sharesfor $1.7 billion, at an average price of $46.93 per share. This activityrepresents about half of our existing share repurchase authorization.
Thank youfor your attention. I will now turn the program back to Charles.
Charles Moorman
Thank you, Jim. As you've seen, the third quarter presentedus with some challenges similar to those we experienced in the first half ofthe year, as we continue to see volume declines on a year-over-year basis.
But even in the face of these volume head winds, as Don hadsaid, we were able to realize an improvement in revenue per unit, which speaksto our continuing ability to improve yield for our services. Despite some near-term economic and legislative uncertainty,we are confident that the long-term fundamentals continue to favor the marketfor our transportation services.
We are also convinced that while thefundamentals are on our side, our future success will depend to a large extenton our ability to provide a superior level of customer service. As I mentioned earlier, we're seeing continued improvementin our service, as the result of our ongoing investments and initiatives.
Allof our internal operating and metrics improved both quarter-over-quarter andyear-over-year. As did two of the three public metrics, terminal dwell time andcars online.
System velocity remained constant, but this is in the faceof the elimination of several of our automotive related schedules. These weresome of our faster schedules so that the result has been that our theoreticalmaximum system velocity has been slightly reduced.
So, we're very comfortablewith the fact that our overall velocity has remained constant. The important point here is that our overall asset velocitycontinues to improve with resulting benefits in both customer service, andreduced costs.
Now, on the cost side, as Jim mentioned, we are continuing towork on our operating costs, wherever possible. But with the philosophy that weare not cutting in those areas where we know that it will cost us additionaldollars to catch up in the future.
Jim gave you a couple of examples. Another is headcount.
Youwill see that our employment numbers are down quarter-over-quarter for the pasttwo quarters, as we have cut back on hiring. And we expect that trend tocontinue.
However, having said all of this about costs, we think thatwhile an operating ratio of 71.1% for the quarter was good, we know it wasstill higher than last year's. We are still intent, as we always have been at NorfolkSouthern, on operating ratio improvement over the long-term, and we remainfocused on reducing costs wherever possible.
On the legislative and regulatory front, as you all know, wealong with the rest of the rail industry, face some significant challenges. Weat Norfolk Southern are committedto promoting fiscally sound legislative policy that encourages rail investment.And it offers an environmentally friendly solution to our nation's growinginfrastructure crisis.
The rail industry has an important role to play astransportation capacity inevitably becomes more constrained in this country.And I remain optimistic that policy makers understand that. As we move forward, NorfolkSouthern will continue to closely monitor business conditions.
As I said,exercise cost discipline wherever and whenever possible, but withoutsacrificing service quality or deferring maintenance; continue to review ouroperating plan, commensurate with demand and make adjustments where necessaryto ensure optimum asset utilization and network efficiency. Looking at the fourth quarter and at least the first half of2008, as Don indicated, we are somewhat guarded as to economic conditions.
Wedo expect to remain on course to price our service to reflect the value that weare delivering. Widening the lens, as I've said, we remain confident in ourlong-term opportunities and anticipate that demand will strengthen as thedomestic and global economies expand.
We continue to focus on new products, and innovative servicesolutions to meet this growing demand as we move forward. Our track record forvolume growth over the past five years shows you what NorfolkSouthern can do in a strong economy.
And we fully expect that growth tocontinue as the economy rebounds. Thank you and I will now turn the program over to theoperator so we can begin the question-and-answer session.
Operator
(OperatorInstructions). Our first question comes from the line of Tom Wadewitz with JPMorgan Chase.
Tom Wadewitz - JPMorgan Chase
On the yield side, you explained some of the mix factors andI wonder if you could break down what came from price and what came from fueland what came from mix. And on the coal side, is this just a one-quarter event,where coal yields are weaker on the mix issues or is that something which isgoing to persist for a few more quarters?
Donald Seale
With respect to coal, it is all a matter of timing ofre-pricing of contracts. We talked a little bit about that in the secondquarter.
We had very little activity on re-pricing during the third quarter. That will begin to transition, as we get into the fourthquarter, but most of that will be visible in the first quarter of '08 movingforward.
We do expect utility coal, which is higher rated than some of theriver coal that we're handling today, hopefully to pick up as stockpilescontinue to be challenged by fairly good weather for coal burning in Septemberand October, and coming out of the summer months.
Tom Wadewitz - JPMorgan Chase
Was there something unusual in the comparison quarter on thecoal yield? Because it was just surprising to see yields, it looks like theywere actually down year-over-year.
And now that was a bit surprising to see.
Donald Seale
Well as I mentioned with Central App utility tonnage down by10% in the quarter and some of our very, very short haul traffic being up asstrong as it was, as I mentioned, the Ohio river traffic, one of those moves, 26 miles in length, was up 21%. Sowe pretty much had a perfect storm with respect to mix and coal.
I don't seethat as being an indication of any change in yield going forward. One other thing that I would mention, too.
This cuts acrossour entire book of business, particularly our merchandise and our coal, is thatyear-over-year with respect to fuel, our actual fuel surcharge for theaggregate was about a $3.90 per barrel less average cost of West Texas Intermediatecrude oil this year versus last year. It was actually $72.10 in '06 versus$68.36 in 2007.
So we had an effective lower fuel cost in terms of West Texas Intermediate crude. And also, our coverage as I mentioned in the second quarteris about 93%, and we will not see that continue to go up until we can get somelegacy contracts expiring and they're re-priced with fuel surcharges.
Tom Wadewitz - JPMorgan Chase
So I might have missed this, but did you talk about, if youback out fuel and mix effect, any kind of pure price number in the quarter?
Donald Seale
I did not provide that, but I would direct you back to thefirst quarter when we looked at a 2% RPU gain, and we did back out the Katrinarelated higher RPU traffic and generated 2%; there is a lot of similarity tothe first quarter and the third quarter.
Tom Wadewitz - JPMorgan Chase
Okay. So 2% is that type of area for the pure price number?
Donald Seale
No. What I'm saying is that it is higher than that Tom.
The lowrated RPU traffic washed out a higher actual effective price.
Tom Wadewitz - JPMorgan Chase
Okay. My recollection was you had talked about kind of 4%effective price in prior quarters?
Donald Seale
That's correct.
Tom Wadewitz - JPMorgan Chase
Okay. Great.
And then one, I guess for Wick or for Steve, ifwe look at the other railroads results, we saw a meaningful reduction in headcounton a year-over-year basis, something around 1%, a little bit more maybe forsome of the other railroads and your headcount was actually up a little bit. Is there room for you to be more aggressive on headcountreduction?
And especially in light of some caution on the volume outlook? Orhow should we think about that?
Because it is a meaningful difference versuswhat we're seeing from the other U.S.rails.
Stephen Tobias
As Wick spoke specifically to, and both Jim and Don alludedto in their presentations this morning, we really do focus on the long-termhere, rather than a quarter-by-quarter comparison per se. Are there opportunities down the road?
Certainly. And Iwould say that we are positioned to either increase our employment if theeconomy turns in the right direction and we determine that to be necessary, ortake other steps that if it goes the wrong way, as we have displayed in thepast.
Charles Moorman
To build on that, one of the things that we have looked verycarefully at, Steve and his team is furloughing employees. We have chosen notto do that at this time.
Basically because where we think we have thoseopportunities, we think that the employees that are furloughed, that will beeffectively many of our newer hires, that we will lose them. And we have invested a fair amount in those employees, andwe think that that's an investment that we would rather hang on to.
Now, in thelight of continued softness in the economy, as Steve indicated, we will takemore aggressive steps if need be. But I think what you're seeing is, and we talked about this,as you know in the past couple of years is the other way to bring headcountdown is to simply reduce hiring, which we have done, and I think you will seeour numbers continue to trend in the direction that you're seeing them now.
Tom Wadewitz - JPMorgan
So if we think about attrition, and you might actually seeyear-over-year headcounts start to go down, is there just a little bit of a lagto the impact of the attrition, is that fair?
Charles Moorman
I think that is a fair comment. Operator Our next question comes from the line of William Greene withMorgan Stanley.
William Greene -Morgan Stanley
Good morning. Just real quick on the casualty and otherline, can you break out for us how much of that might have been one-time, orwon't repeat in future quarters?
James Squires
As I said, we have seen favorability, not only this quarter,but in the first two quarters of the year as well, in terms of the personalinjury actuarial adjustments, and we think that that's a reflection of ourcontinuing commitment to safety. So we would expect and hope for continuedfavorability in that part of the casualties and other claims.
There was also an insurance settlement in the quarter, thatwas $5 million of the 17 favorable, and that is something that will occursporadically, but certainly not on a continuing basis.
William Greene - MorganStanley
Okay. And then if I can just come back to coal for a second,with Don, if you look at the projects that you outlined here, and talk aboutsort of a $6 million increase, I presume there is also some facilities orchanges that will occur in the business on your lines that may cause an offsetto that.
So if you think of kind of the net potential here, how muchshould it actually be?
Donald Seale
Actually, we're talking about 6 million tons of additionalsourcing with those four projects. I also mentioned that Buchanan and PinnacleCreek mines.
They have been down for the last several months, and PinnacleCreek is beginning to ramp back up this week, and we expect Buchanan to comeback online within the next 60 days or so. Those two mines combined are 7.2 million tons.
So we havethose two mines coming back, plus this sourcing at the additional project. Sowe're continuing to look very closely at coal sourcing not only in the CentralApp region, but also the Northern App region, as well as the Illinois base andthe PRB.
So it is just part of our overall strategy to continue tolook at coal sourcing as the markets change.
William Greene -Morgan Stanley
Right. But I presume we shouldn't be adding in sort of all13 million tons here?
There's got to be some puts and takes, so what are thenegative issues that are going on beyond just utility stockpiles being high?
Donald Seale
Well, the market itself will drive the consumption of coal.So as this new production comes on, certainly some of it may go into the exportmarket, some of it may go to the utility market, but we want that additionalsourcing available as markets continue to change and evolve and that is thepoint here, as opposed to adding it in, as all new business. This will be part of our sourcing to go to current markets,and as markets change.
William Greene -Morgan Stanley
And then just one last question on CapEx, you are prettydisciplined in terms of how you spend it each year so I wouldn't expect it tobe much different, but given the weakness that we've seen and that yousuggested that can continue into the first half, any reason to think '08 CapExwould drop?
Charles Moorman
You know, we haven't finished working through the capitalbudget yet. We will be announcing that next month.
And so I really don't wantto foreshadow anything, because we really don't know what the numbers are. But capital expenditures are in general, as all of you know,the sum of two components, one is the money that we spend on the maintenanceand renewal of our existing physical plant, and the other is for new capacityand new business, and we will certainly look very hard at the businessopportunities.
But we look hard understanding that a lot of the capitalthat is employed on the railroad is for projects that have a fairly long leadtime and so we will take that into account, not only looking at immediatebusiness conditions, but where we think our business is going to go over thenext few years.
Operator
Our next question comes from the line of Ken Hoexter withMerrill Lynch.
Ken Hoexter - MerrillLynch
Good morning. If we can switch over to intermodal for asecond, I think, Don, you mentioned that there was strong demand particularlyon the East Coast, yet some weak pricing.
And I think you noted that trailerswere up pretty strong. Can you go over it again in detail of where you're seeingthe strength and weakness come in, just so as the trucking market continues todeteriorate, how much of an impact is that on your eastern business.
Donald Seale
First with respect to trailers as we discussed in the past,we are continuing to see a migration away from rail trailers in intermodal tocontainers. And our trailer traffic has been higher RPU, but not necessarilyhigher margined intermodal traffic in the past.
That business continued to transition down in the third quarter.It was down 20%. So trailer traffic was down 20% in the quarter.
And thatimpacted mix because it is higher RPU, but not necessarily higherprofitability. In fact, we do better with double stack container traffic.
Now, with respect to what is taking place in the ports, as Imentioned, we continue to see a shifting of vessel rotations to the East Coast,all water, using the Panama Canal and the Suez Canal, and our business throughthe East Coast ports in the quarter was up 16%, and we saw a correspondingdecline of about 17% in our transcontinental import traffic. And I think that if you look at the numbers through some ofthe West Coast ports, for the first time we're seeing actual year-over-yeardeclines, Los Angeles being case inpoint, which was down about 7% in August and haven't seen the number inSeptember.
So that is the dynamic on the international business. On thedomestic truckload business, we're continuing to see a steady pace ofconversion to intermodal in our local NS network.
But it was not strong enoughto offset softness in the LTL market, as well as some of the domestic truckloadtraffic going back to the highway to protect current driver pools. And they have worked hard to recruit drivers in certainpools, and with softness in that market, and they're trying to protect those asfar as they can, and not let the people get away.
Ken Hoexter - MerrillLynch
That simplified it. Thank you.
And then can you talk aboutthe Meridian Speedway then? Is the traffic then slower over that corridor thanyou would have expected because of the drop in the West Coast traffic movingeast?
Donald Seale
We're seeing some slower patterns on international tradecoming from the west, but we're very encouraged with respect to the domesticfreight that is moving in that corridor. I mentioned the Blue Streak service.And yet we're now running six westbound trains per week, and five eastboundtrains per week, with service better than 95% on time.
It’s a very attractive product, fourth morning availability,in Atlanta, or back on the WestCoast, and we feel very good about how we're positioned on that service.
Ken Hoexter - MerrillLynch
Okay. So just looking forward, you do continue to expectsome of that, on that last, you said the reverse to the highway, because of thetruck pricing, I just want to get kind of a concept of how much you feel thatit’s really exposed to that trucking competition.
Donald Seale
Well, it depends on which segment we're talking about.Certainly long haul freight is less susceptible to diversion than some of theshorter haul intermodal traffic. Although we're continuing to see some of the largeasset-based truckload carriers, do a good job of continuing to convert tointermodal.
So we don't see this pattern that we're seeing of excesstrucking supply. While we're seeing today, in today's economy, we certainlydon't see it extending out for a protracted period of time.
Ken Hoexter - MerrillLynch
Can you give a concept of how much is that short haul versuslong haul traffic of the intermodal?
Donald Seale
Well, as we convert transcontinental traffic, as the steamship lines make the decision to come to the East Coast, a good example of thatis our business is substantially up at the port of Savannah to Atlanta.And that’s a shorter haul than Memphisto Atlanta. That is a profitablelane, it’s a very heavy double stack lane and that’s in the working parts ofmix when you look at RPU and what we've reported in the third quarter.
Charles Moorman
I think to some extent the answer to your question is whenyou see shifts like we have seen third quarter over third quarter, in WestCoast versus East Coast, and this is a very dynamic market for us now, and theratio of long haul to short haul, or what we even consider to be short haul,the definitions are changing fairly rapidly.
Ken Hoexter - MerrillLynch
Okay. And then last question, if I can, just on the network,you’d kind of started out your opening comments talking about the upgrade ofthe track, how much of it now is double stack capable particularly on thatcorridor that you were extending out?
Charles Moorman
Well, the Heartland Corridor project, which is the openingup of the clearances on the shortest routes, between the port of Norfolk and the Midwest,aimed primarily at our new major intermodal terminal in Columbus,is just beginning. We have a healthy container business out in the port of Norfolk today that we move viadouble stack, but we move it in a more circuitous route, either up through Harrisburg, Pennsylvania, and over, or over actuallythrough Knoxville, Tennessee,and up through Cincinnati.
So what this project does is takes a day or more out of thetransit time, and really makes it a much more attractive transportation productfor people who want to bring their goods in through the port of Norfolk, which is growing veryrapidly, and then move them into the Midwest. The Heartland Corridor really though is, I would say, justabout the last piece of the puzzle in terms of Norfolk Southern's major routesin handling double stacked traffic.
Our next challenge, and this goes also to your question ofthe intermodal growth is that we've outlined initiatives like our Crescent Corridor,where we think there is a huge, to some extent, untapped long haul intermodalfranchise that we can develop, as we put in new train service, and addcapacity, and put more truck-like service in place, and we're working very hardright now on trying to develop that corridor as well. One of the things that we look at in a time like this, iswhere are there new products, where are there new services that we can start tointroduce, because quite frankly, over the past three or four years, we had ourhands full of just handling the product in the lanes that we have, and I thinkwe have some exciting new products that will be rolling out over the next year.
Operator
Our next question comes from the line of Jason Seidl withCredit Suisse.
Jason Seidl - CreditSuisse
You talked a little bit about some of the changes in revenueper unit, and alluded to where you might be on price excluding some of the putsand takes via Tom's comments. Where are you weakest in terms of the pricing market?
Is itin the housing related and truck competitive business?
Donald Seale
Our RPU message here this morning, there are threecomponents to it: the first is timing of re-pricing, particularly inmerchandise, as well as coal. It’s all about having the price instruments,contracts, quotes, et cetera, available for re-pricing - that's a timing issue.
The second thing is reduced fuel surcharge in the quarter.As I pointed out earlier, we actually had an effective lower WTI average in thequarter. Plus last year, we were still ramping up fuel surcharge coverage, andnow we're at 93% and we're pretty much flat with respect to gaining anyadditional leverage in fuel until we have contracts roll over, legacycontracts.
And then the third thing is the mix. We continue to have alot of change in mix.
We mentioned the mix in intermodal, the shifting of porttraffic, et cetera. A lot of change in mix on coal for the quarter.
River coal versus long haul Central App to the South coal. Imentioned in the comments the Chesapeake Energy plant in Chesapeake, Virginia, which is about 1.9 million tonson an annual basis, converted from Central App coal to imported coal from Venezuela.
And that is having an impact on our RPU as well. And I alsomentioned that import coal, in one of the first slides I showed, import coal isactually down in the quarter for us as well.
And that impacted RPU.
Jason Seidl - CreditSuisse
In relation to the fuel surcharge, one of your competitorsout there said it takes about two months to recover on a lag. Are you on atwo-month lag as well?
Donald Seale
We have a 60-day lag in our program to allow customers toadjust their databases for it.
Jason Seidl - CreditSuisse
Okay. Great.
And one last question, can you give us anupdate on the Maersk port and when we should start seeing volumes flow intoyour network?
Donald Seale
The new Maersk terminal in Portsmouth, Virginia here in Norfolkat the Port of HamptonRoads opened officially in September; they are beginning to rotate vesselsthrough that facility. We're beginning to handle traffic through it.
And it’sin the process of ramping up.
Operator
Our next question comes from Scott Flower with Banc ofAmerica Securities.
Scott Flower - Bancof America Securities
Just a couple of questions, one is, and I know that you allhave been very clear over time that about half of your book rolls every year,but how much in the way as we look toward '08 will actually be legacy contractsor contracts that really haven't seen the light of day for several years?
Charles Moorman
Scott, as we've explained I think in the previous quarters,we are getting down to the point where we have very few so-called legacycontracts left, that have not been treated within the last three to five years. We have been moving toward a shorter duration of contractsfor a number of years.
We still do have several large contracts like one in theautomotive sector, another one or two in coal, and then a couple in merchandisethat are longer term in nature that will take some time to get through. But it does not represent the majority of our business, itrepresents the minority of it.
Scott Flower - Bancof America Securities
But will any of those occur in '08? Or are those furtherout?
Donald Seale
They're further out.
Scott Flower - Bancof America Securities
Okay. One other thing, on the marketing side, you noted andthis is just a note, but you mentioned it, obviously you talked about coalgeneration being at a lower percentage, are you actually seeing any fuelshifting or why would coal generation be at a lower rate than electricitygeneration growth in your territory?
I'm just curious about that.
Charles Moorman
When you look back over what has taken place this year inthe weather patterns for utility coal, for utility and electrical generation,we have seen a lot of spikes in cold weather, when you look at the firstquarter, very mild January, February, and then about the middle of March, wehad a cold spell, a spike-up in cold weather. And then it lasted for about four or five weeks, and thenback down into more modest weather.
With the price of natural gas running $5,$4.50, $5, $5.50, we've seen gas used at peaking plants to take up the slackwith respect to peaks in demand for electrical generation. So we've seen somegas competition during that time.
Scott Flower - Bancof America Securities
Okay. And then two other quick questions, one for you, Don,and I guess one for Jim.
You talked a little bit about obviously some of theshifting dynamics in the import/export market. Are you indifferent from acontribution standpoint of whether import/export boxes, primarily imports, cometo you from western gateways versus eastern gateways?
Because obviously you mentioned Savannahpicking up versus where you may have seen in Memphisand there is a length of haul delta. And I'm just trying to get a sense from adifferent standpoint is it indifference or is there favorability one way oranother from all-in contribution standpoint?
Donald Seale
Our international import, our container business includingexports, half is East Coast and half is West Coast. And we certainly areindifferent.
Others make decisions with respect to which ports are used.
Scott Flower - Bancof America Securities
Last question is, Jim, obviously things are a little bituneven in the economy, and you all are very long-term in nature, but yetobviously, the stock is decent in the quarter but still probably not to thelevels we've seen in the last few years and you are delevering. I'm just wondering whether you had any thoughts about theshare repurchase program, and obviously, you're generating cash, whether youmight be more aggressive with that.
I know that you mentioned on your analystday over the next several years you would contemplate perhaps adding moreleverage. I'm just trying to get a sense of how you think about that.
James Squires
As we outlined at our investor day in June, we do think thatthere is room for meaningful additional leverage while maintaining our stronginvestment grade status. So over the next few years, yes, I think you will seea net addition to leverage in our capital structure.
And that is likely to go toward share repurchases. We'vebeen pretty aggressive with the program and we've tried to be opportunisticwith the program, and have targeted periods when we think that we can add themost shareholder value through share repurchases and we will continue to pursuethat approach for the next couple of years.
Operator
Our next question comes from the line of Edward Wolfe withBear Stearns.
Edward Wolfe - BearStearns
Hi, Good morning. I know this has been asked but I don'tthink it's really has been answered, the 2.5% yield, can you break that down byprice mix and fuel?
Donald Seale
We do not break it out that way. And we haven't in the past.But I will reiterate that flat fuel, or slightly decline in fuel, heavy, heavymix impact with respect to coal, and metals and construction, in particular,some in intermodal as well, and then also a quarter with relatively quietopportunities for re-pricing, because of the timing of contracts.
Edward Wolfe - BearStearns
Okay, but outside of re-pricing, same stores kind of sales,you had talked about being in that 4% range, I thought in prior quarters. Whereare you relative to that?
It feels like it is a little less good, probably. Isthat fair?
Donald Seale
I would be comfortable saying that we're in that range.
Edward Wolfe - BearStearns
Okay. You just mentioned, Don, that East and West was abouthalf of your business.
Is that revenue or volume?
Donald Seale
The East/West revenue split is what we're talking about.
Edward Wolfe - BearStearns
And as far as you're concerned, the profitability on a moveis fairly similar?
Donald Seale
We are indifferent with respect to the ports. The steam shiplines are making those decisions, Ed, with respect to vessel rotations andvessel utilization, and being partners with that industry, we work with them tosupport them.
Edward Wolfe - BearStearns
Okay. You mentioned that you talked about a change in thecoal business toward shorter haul, what is driving that?
Donald Seale
I think part of that is just certain contracts that havebeen increased. The Ohio River coal certainly is veryactive.
Scrubber installation may be coming into play for some of this, aswell. But I think also the fact that stockpiles in the Southgenerally have been higher over the past 12 months, a little lower in theNorth, so our utility coal in the North from Pittsburgh 8 actually is lookingpretty good, and it was up in the quarter, while our utility coal from CentralApp to the South was down 10%.
That is a big spread and a big hit on RPU withrespect to mix effect.
Edward Wolfe - BearStearns
That's good color. Thank you.
The headcount again, up 0.4year-over-year. I would think by attrition, now that you have three quarters ofnegative 4% volume under your belt, if you wanted to by attrition, how quicklycould you go from positive 0.4 to negative 4?
Charles Moorman
Well I don't know how fast you go to a particular negativenumber, but I think that as I mentioned earlier, the fact that we have sloweddown our hiring is going to continue to take our numbers down as we look atattrition. As I talked about before, we have a work force in generalwhere the demographics are such that all we have to do is take our hand off thehiring lever a little bit, and it doesn't take too long before our numbersstart to come down.
And that's what you're seeing, and I think that's what youwill continue to see.
Edward Wolfe - BearStearns
4% would be about 1200 jobs. I'm guessing that doesn't taketoo many quarters, does it?
Charles Moorman
It just depends on how much, if any, we continue to hire. Soit also depends on business conditions and where we need people.
I will pointout, and this is part of the numbers you see and this is another challenge thatwe talked about, one place that we continue to look at our demographics, and welook at our headcount, and we look at our plans, and we have not slacked off,and that is in trying to bring in people into our supervisory work force,particularly at entry levels because we have a big demographic shift coming upin this company in the next five years, and we think to not get ready for that,and to keep the pump primed with new training and new entry level supervisorswould be an imprudent thing to do.
Edward Wolfe - BearStearns
What do you think the timing is for volumes to be betterthan the minus 4 range that we are still in through last week at this point? Doyou think, you look out a couple of quarters, and you expect them to flattenout at some point?
What's your timing?
Charles Moorman
At a certain point, you get to the point where you'relooking at your comps, but I have learned that every time I think I have aclear insight on where volumes are going, I'm wrong. So we just try not to makepredictions on that.
I think that we, along with everyone else that you read,thinks that this economy has been impacted by the housing slowdown, and that'ssomething that is going to continue, and the housing market has an impact ontransportation volumes in this country, all of the rails and the truckingindustry as well.
Operator
Our next question comes from the line of David Feinberg withGoldman Sachs.
David Feinberg -Goldman Sachs
Two questions. One housekeeping.
Just want to confirm, theother income and the tax benefit that you get from synthetic fuel, thatdisappears in 2008, the fourth quarter is the last quarter we should see that,correct?
Donald Seale
Yes, that's correct.
David Feinberg -Goldman Sachs
And then your comments regarding shipper vessel rotation, interms of going in all water passage through the East Coast, do you view that asa secular change or a temporary change based solely on the weak demandenvironment and if and when the economy heats back up, the shippers will lookto turn their assets quicker and go back to a higher mix of West Coast portsrelative to East Coast.
Donald Seale
We see it as an indication, a manifestation most likely of atrend that will continue. Maersk was mentioned earlier.
They have made a rathersubstantial financial investment in a private terminal at the Port of Hampton Roads, and that terminalcan accommodate very, very large vessels, the largest vessels that theyoperate. So I would fully expect them to continue to use the EastCoast and I am not saying that the West Coast ports will not continue to behigh volume, they will.
But I think both coasts are going to be used tooptimize vessel rotations, and to optimize supply chains.
Operator
Our next question comes from the line of John Larkin withStifel Nicolaus.
John Larkin - StifelNicolaus & Company
Good morning, gentlemen. I'm fascinated by the trafficgrowth you've seen in the Savannahto Atlanta market, especially withmaybe some excess trucks available in this sloppy market.
It is about a250-mile length of haul. Historically intermodal economics begin to break downsomewhere around 500 miles.Could you talk little bit about what’s made that particular traffic laneprofitable.
I think you said it was rather profitable. I would just like tounderstand the economics little bit better if possible.
Donald Seale
It’s all about double stack capability and running densetraffic and getting good utilization in the lane and we're seeing both ofthose.
John Larkin - StifelNicolaus & Company
Can you apply that same kind of operating philosophy tomarkets like say Charleston to Charlotteand other such short haul markets? Do you think that theory is applicable toother markets?
Donald Seale
One of the things, we're looking at very closely. And Wickmentioned the Crescent Corridor, of course there are longer haul segments inthe Crescent Corridor and then there are shorter haul segments in the crescent corridor.
We think the goal posts are moving with respect to length ofhaul assumptions that used to be out there. And I think they will continue toevolve and change overtime, as highway congestion, highway costs, driveravailability, and all of the things we generally look at continue to evolve andchange.
So double stack technology brings a very efficient mode oftransportation to a market, but it’s all about creating velocity in that lane,and running full heavy trains, which the lane from Savannahto Atlanta certainly reflects.
John Larkin - StifelNicolaus & Company
Good answer. Thank you very much.
And turning the page a bitto export coal, up very nicely in the quarter. The dollar looks like it isgetting weaker.
The Chinese continue to sap some of coal supplies fromelsewhere in the world. Is this the time when the export coal markets can kindof return to its heyday of 10 and 20 years ago?
Charles Moorman
Let me say before Don says anything, we would enjoy that.
John Larkin - StifelNicolaus & Company
I'm sure that's right.
Donald Seale
We certainly would. But we don't see the world market todaybeing anywhere near the same as it was in the early '80s or even the early '90sand we don't see a return to the level of U.S.coals certainly in Asia, because the Australians stillhave that market, the proximity advantage.
But in Europe, U.S.coals are more than competitive in the face of a weaker dollar, and we'reseeing the Australians have a much more difficult time from a cost standpoint,with bulk vessel costs from Australiaall the way to Europe, as well as port congestion, andjust being able to meet overall demand. So U.S.coals with the weaker dollar in Europe are certainlywell positioned and our volumes reflect that.
John Larkin - StifelNicolaus & Company
Okay. Then just one final question, on operations, the lastone railroad that had the best improvement in operating ratio I believe reducedtrain storage by about 5% on a 1% increase in volume.
Clearly your volume notquite that strong in this tough environment, but are there operational tweaksto the operating plan that could begin to achieve the kind of benefits that theparticular western railroad I'm talking about achieved through reducing trainstorage?
Stephen Tobias
There is a bit of difference in comparing east and west, ofcourse. But in general, as Wick spoke to a number of different productopportunities, which we are working on and have worked on, our opportunity towork both with origin destination point payers and even within commoditygroups, to reduce cycle time, reduce costs, improve our opportunities acrossthe spectrum of the sales packages that we offer and products that we offer toour customer base, it is an ongoing living, every day exercise.
And yes, thereare opportunities for us to continue to reduce those cycle times and take costout improve our equipment flows and better serve our customers.
Operator
Our last question comes from the line of John Barnes withBB&T Capital Markets.
John Barnes -BB&T Capital Markets
Hi, Good morning. Don, and Steve, I guess, to your answerson this East Coast versus West Coast intermodal lane, if this is a morepermanent shift, Don, can you give us an idea of two or three years out, what’sthe revenue mix going to look like?
If it is 50/50 today, does it become moreheavily weighted towards East Coast revenue generation from the intermodal? And then I guess towards Steve how that shift, how does itchange your CapEx outlook for your intermodal franchise?
Is there some moreopportunity for Heartland Corridor type investment or is it just kind of moreof ‘can I continue to invest where have you been investing’?
Donald Seale
Well, the crystal ball is a little bit cloudy in terms ofhow it’s going to continually evolve and whether that 50/50 percentage willcontinue to change. I think you will see, with the advent of the HeartlandCorridor, the opening of Rickenbacker, you will see our mix of that trafficcoming through the East Coast ports continue to change.
Norfolkup to the Columbus, OhioValley, Detroit, and back to Chicago,is very good long-haul traffic. And we have the infrastructure in place, we already have therailroad capacity, when we clear the tunnels--the reason we are clearing thetunnels is to tap that additional capacity--we will have an overnight serviceto Chicago to the Ohio Valley, which will enhance assetturns, asset utilization, and better customer service.
And that's just oneexample. We will also see traffic from the southeastern ports possibly go backto the gateways.
So there are a lot of moving parts to this, a lot of it’sstill not totally visible. But as we visit with the Asian steamship lines, theyclearly outline to us their long-term plans to use both coasts in a prudentmanner to optimize their overall service.
Stephen Tobias
Much like the capacity we are adding in the HeartlandCorridor, and in the Crescent Corridor concepts, as opportunity presents itselfat the ports, I can assure you that we are presently adding and we will addcapacity if the business case justifies it. Hence going into Savannahto Atlanta corridor, we haveseveral initiatives ongoing both in the city of Savannahand on Atlanta road to improvecapacity and improve and increase through put.
John Barnes -BB&T Capital Markets
Okay. And Steve, the facilities being built in theSoutheast, I was recently in Charleston,they were talking about the development of an intermodal facility in Orangeburg, South Carolina, still a lot of discussionabout the joint facility on the Savannah River in JasperCounty.
If you look at those two facilities, are those going to bejointly served by both eastern rails, or are those facilities being built onone particular rail or the other?
Stephen Tobias
John, in reference to the previous question, and response, Iwill look in my crystal ball and it is now becoming cloudy. There is an unknownelement here that I really can't speak to, but to the extent that we canparticipate where we would not normally have an opportunity to, we wouldcertainly be willing to entertain it.
John Barnes -BB&T Capital Markets
And then last question, for you, on equipment, there hasbeen some discussion this quarter about various levels of equipment currentlyin storage, both locomotives and cars, given your current traffic level, couldyou give us an idea, do you have any equipment stored mothballed, that kind ofthing?
Stephen Tobias
We do in fact have some rolling stock cars in storage. Idon't have very many locomotives in storage.
John Barnes -BB&T Capital Markets
Can you give us magnitude of cars?
Stephen Tobias
6,000 to 7,000.
Operator
There are no further questions at this time. I would like toturn the floor back to management for concluding remarks.
Charles Moorman
In conclusion thanks very much for your time. As always, weappreciate the chance to talk with you.
And as I mentioned earlier, let us knowwhat you think of this format. And we look forward to talking to you again.Thanks.
Operator
Ladies and gentlemen, this concludes today's teleconference.Thank you all for your participation.