Add
NSC to Portfolio
Set Alert
Email to a
Friend
| |||
|
|
Quotes & Info
|
| NSC > SEC Filings for NSC > Form 10-Q on 24-Jul-2008 | All Recent SEC Filings |
24-Jul-2008
Quarterly Report
Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
NS' second-quarter 2008 net income was 15% higher than the prior year due to improved income from railway operations. Railway operating revenues increased 16% as higher average revenue per unit (which includes fuel surcharge) more than offset a 2% reduction in traffic volume. Railway operating expenses, driven by higher fuel costs, increased 16% as compared to the second quarter of 2007, and the railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) increased slightly to 71.1% compared with 71.0% for the second quarter of 2007.
At June 30, 2008, cash and short-term investment balances totaled $454 million. Cash provided by operating activities for the first six months was $1.1 billion and, along with proceeds from borrowings, provided funding for capital expenditures and dividends, as well as share repurchases. In the second quarter of 2008, 3.4 million shares of Norfolk Southern Corporation common stock (Common Stock) were repurchased at a total cost of $218 million. Since inception of the stock repurchase program in 2006, NS has repurchased and retired 54.4 million shares of Common Stock at a total cost of $2.7 billion.
SUMMARIZED RESULTS OF OPERATIONS
Second-quarter 2008 net income was $453 million, up $59 million, or 15%, compared with the same period last year. The improvement primarily resulted from a $109 million increase in income from railway operations and a $25 million increase in other income. Second-quarter net income was reduced by a $74 million increase in income taxes, reflecting both higher pretax income and the absence of benefits associated with synthetic fuel tax credits that expired in 2007.
For the first six months of 2008, net income was $744 million, up $65 million, or 10%, compared with the same period last year. Increases of $159 million in income from railway operations and $25 million in other income were offset in part by a $124 million increase in income taxes.
DETAILED RESULTS OF OPERATIONS
Railway Operating Revenues
Second-quarter 2008 railway operating revenues were $2.8 billion, up $387 million, or 16%, compared with the second quarter of 2007. As shown in the following table, the increases were the result of higher average revenue per unit, including increased fuel surcharges, that were offset in part by lower traffic volume. Fuel surcharges amounted to $410 million in the second quarter (up $231 million) and $729 million for the first six months (up $375 million).
Second Quarter First Six Months
2008 vs. 2007 2008 vs. 2007
Increase (Decrease) Increase (Decrease)
($ in millions)
Revenue per unit/mix $438 $743
Traffic volume (units) (51) (103)
Total $387 $640
|
Revenues, units and average revenue per unit for NS' market groups were as follows:
Second Quarter
Revenues Units Revenue per Unit
2008 2007 2008 2007 2008 2007
($ in millions) (in thousands) ($ per unit)
Coal $ 775 $ 579 448.3 434.6 $ 1,729 $ 1,332
General merchandise:
Chemicals 322 297 103.9 109.7 3,095 2,712
Metals/construction 352 298 210.4 209.8 1,675 1,423
Agr./consumer prod./govt. 326 254 156.6 148.9 2,077 1,701
Automotive 227 255 116.3 146.9 1,954 1,733
Paper/clay/forest 231 216 102.4 109.0 2,261 1,981
General merchandise 1,458 1,320 689.6 724.3 2,115 1,822
Intermodal 532 479 763.1 783.4 698 611
Total $ 2,765 $ 2,378 1,901.0 1,942.3 $ 1,455 $ 1,224
First Six Months
Revenues Units Revenue per Unit
2008 2007 2008 2007 2008 2007
($ in millions) (in thousands) ($ per unit)
Coal $ 1,437 $ 1,136 875.3 854.8 $ 1,642 $ 1,329
General merchandise:
Chemicals 627 571 206.1 215.4 3,041 2,650
Metals/construction 657 573 396.9 395.4 1,657 1,450
Agr./consumer prod./govt. 625 495 308.7 295.6 2,023 1,673
Automotive 455 482 235.9 279.4 1,930 1,726
Paper/clay/forest 446 427 202.6 218.3 2,201 1,958
General merchandise 2,810 2,548 1,350.2 1,404.1 2,081 1,815
Intermodal 1,018 941 1,503.5 1,554.9 677 605
Total $ 5,265 $ 4,625 3,729.0 3,813.8 $ 1,412 $ 1,213
|
Coal
Coal revenues increased $196 million, or 34%, in the second quarter and $301 million, or 26%, in the first six months, compared with the same periods last year. Both increases reflected higher rates, including fuel surcharges, and increased traffic volume (up 3% for the quarter and 2% for the first six months). The higher rates were comprised of pricing increases, contract escalators and the effect of increased longer-haul export coal traffic. For both periods, tonnage handled increased, reflecting improved export volume. Coal tonnage by market was as follows:
Second Quarter First Six Months
2008 2007 2008 2007
(tons in thousands)
Utility 36,072 35,965 71,676 72,181
Export 6,201 3,796 11,974 7,322
Steel 4,745 5,072 8,262 8,702
Industrial 2,250 2,653 4,159 5,050
49,268 47,486 96,071 93,255
|
Utility coal tonnage increased modestly in the second quarter but declined 1% in the first six months as higher export demand and June flooding in the Midwest tightened coal availability for domestic customers. Export coal tonnage increased 63% for the second quarter and 64% for the first six months, reflecting increased global demand coupled with weather-related supply constraints in Australia and reduced export volume from China. D omestic metallurgical coal, coke and iron ore tonnage declined 6% in the second quarter and 5% in the first six months due to constrained coal supply. Industrial coal tonnage decreased 15% for the second quarter and 18% in the first six months compared with 2007, principally due to coal supply constraints.
NS is currently involved in litigation with Virginia Electric and Power Company/Old Dominion Electric Cooperative (Virginia Power) regarding rate adjustment provisions in a transportation contract between them. In 2007, the Virginia Supreme Court issued a decision that remanded the case to the trial court on the grounds that neither of its prior decisions constituted a final order. On April 17, 2008, the trial court entered a final order granting NS monetary damages, including interest, and prescribing the methodology for determining future rates. Virginia Power filed its Notice of Appeal on May 7, 2008. Future developments and the ultimate resolution of this matter could result in NS recognizing additional revenues related to this dispute, which could have a favorable impact on results of operations in a particular year or quarter.
Coal revenues for the remainder of the year are expected to be up compared to prior year levels, due to higher average revenue per unit and continued strength in the export market.
General Merchandise
General merchandise revenues increased $138 million, or 10%, in the second quarter and $262 million, or 10%, in the first six months, compared with the same periods last year, a result of higher average revenue per unit. The improvement in average revenue per unit reflected continued market-based pricing in all groups and higher fuel surcharges . Traffic volume declined 5% for the quarter and 4% for the first six months, driven by lower automotive volumes. Chemicals traffic volume decreased 5% for the second quarter and 4% for the first six months, reflecting continued weakness in plastics and petroleum-based products linked to housing and roadway construction declines, respectively. Metals and construction volume was up slightly as increased carloads from metals offset declines in housing-related markets. A griculture, consumer products and government volume increased 5% for the second quarter and 4% for the first six months, reflecting increases in ethanol, corn and feed shipments. Automotive volumes decreased 21% for the second quarter and 16% for the first six months, reflecting reduced North American sales and production. Automotive manufacturers, especially the domestic producers, continue to experience sales declines as consumers are opting for more fuel efficient vehicles. Ford, General Motors and Chrysler combined operate 17 of 27 assembly plants served by NS. Two of these assembly plants implemented shift reductions during the first half of 2008, and two other plants have announced plans to reduce shifts in the third quarter. In addition, one manufacturer has announced plans to close an assembly plant later in the year. P aper, clay and forest traffic volume was down 6% for the second quarter and 7% for the first six months, reflecting lower volumes related to the housing slowdown and continued decline in conventional paper markets.
General merchandise revenues are expected to be higher for the remainder of the year as improved year-over-year pricing should continue to offset lower traffic volume.
Intermodal
Intermodal revenues increased $53 million, or 11%, in the second quarter and $77 million, or 8%, for the first six months, compared with the same periods last year, primarily due to higher average revenue per unit including fuel surcharges. Intermodal volume declined 3% in the second quarter and first six months. Domestic volume (which includes truckload and intermodal marketing companies' [IMC] volumes) increased 7% for the second quarter, and was up slightly for the first six months, reflecting the relative efficiency of intermodal versus over-the-road transportation in a high fuel cost environment. International traffic volume declined 8% for the second quarter and 7% for the first six months, primarily driven by a soft economy and less inland rail movement of West Coast port traffic that offset East Coast port volume growth. The Premium business, which includes parcel and less-than-truckload (LTL) carriers, decreased 6% for the second quarter and 4% for the first six months, as reduced private empty movements and soft parcel business offset LTL conversions. Triple Crown Services Company volume was down 1% for the second quarter, but improved slightly for the first six months.
Intermodal revenues for the remainder of the year are expected to reflect growth due to modestly higher traffic volume and increased revenue per unit.
Railway Operating Expenses
Second-quarter railway operating expenses were $2.0 billion in 2008, up $278 million, or 16%, compared with the same period last year. For the first six months, railway operating expenses were $3.9 billion, up $481 million, or 14%, compared with the same period last year.
Compensation and benefits expenses increased $33 million, or 5%, in the second quarter and $57 million, or 4%, in the first six months, compared with the same periods last year. The changes reflected increased incentive compensation due to a higher projected payout (up $19 million for the quarter and $22 million for the first six months), increased stock-based compensation primarily due to a stock price increase (up $13 million for the quarter and $27 million for the first six months), increased pay rates (up $10 million for the quarter and $20 million for the first six months) and the absence of a second-quarter 2007 settlement of a $9 million payroll tax refund claim that were offset in part by lower health and welfare benefits expenses (down $10 million for the quarter and $14 million for the first six months).
Purchased services and rents increased $20 million, or 5%, in the second quarter and $11 million, or 1%, in the first six months, compared with the same periods last year. The increases were driven by higher intermodal operational costs, higher roadway repair expenses and increased professional and legal services that were offset in part by lower equipment rents.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased $212 million, or 76%, for the second quarter and $368 million, or 70%, for the first six months, compared with the same periods last year, reflecting sharply higher fuel prices.
Materials and other expenses (including the estimates of costs related to personal injury, property damage and environmental matters) increased $6 million, or 3%, in the second quarter and $32 million, or 8%, for the first six months, compared with the same periods last year. The quarterly increase reflected higher expenses associated with derailments and increased materials costs for locomotive and freight car repairs that were offset in part by $12 million of favorable personal injury claims and $4 million of environmental costs development. The year-to-date increase also reflected the above as well as costs associated with the Avondale Mills settlement related to the Graniteville accident (see additional discussion below). The following table shows the components of materials and other expenses.
Second Quarter First Six Months
2008 2007 2008 2007
(in millions)
Materials $ 96 $ 91 $ 197 $ 180
Casualties and other claims 42 46 107 98
Other 76 71 150 144
$ 214 $ 208 $ 454 $ 422
|
In April 2008, NS settled the lawsuit brought by Avondale Mills for claims associated with the Jan. 6, 2005, derailment in Graniteville, SC. A portion of the settlement will not be reimbursed by insurance and was included in first-quarter 2008 expenses. The total liability related to the derailment represents NS' best estimate based on current facts and circumstances. The estimate includes amounts related to business property damage and other economic losses, personal injury and individual property damage claims as well as third-party response costs. NS' commercial insurance policies are expected to cover substantially all expenses related to this derailment above the unreimbursed portion and NS' self-insured retention, including NS' response costs and legal fees. The Consolidated Balance Sheets reflect current and long-term receivables for estimated recoveries from NS' insurance carriers. On July 1, 2008, NS filed a demand for arbitration against one of its insurance carriers that has failed to respond to an insurance claim submitted by NS. Accordingly, it is likely that all or part of the recorded recovery attributable to such carrier ($100 million) will be contested. NS believes these expenses are covered by the insurance policy and that recovery of any contested amount is probable, in that if the carrier contests payment an arbitrator would determine the settlement amounts to be reasonable and that the insurer's refusal to consent to and to fund the settlement was a breach of contract.
Other income - net
Other income - net increased $25 million in both the second quarter and the first six months of 2008, compared with the same periods in 2007. The increases reflect the absence of expenses related to synthetic fuel investments (down $26 million for the quarter and $46 million for the first six months), reduced interest expense (down $9 million for the quarter and $10 million for the first six months) due to a second-quarter adjustment to reflect the expected outcome of certain tax examinations, and more gains on the sale of property (up $5 million for the quarter and $8 million for the first six months). These benefits were offset in part by lower returns and higher borrowing costs on corporate-owned life insurance (down $11 million for the quarter and $32 million for the first six months) and lower interest income (down $7 million for the quarter and $17 million for the first six months).
Provision for Income Taxes
The second-quarter and year-to-date effective income tax rates were 38.2% and 38.5% in 2008, compared with 34.3% and 33.4% for the same periods last year. The increases were largely due to the absence of synthetic fuel-related credits which expired at the end of 2007.
NS' consolidated federal income tax returns for 2004 and 2005 are being audited by the Internal Revenue Service and the audit is expected to be completed during the third quarter (see Note 2).
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, NS' principal source of liquidity, was $1.1 billion for the first six months of 2008 and 2007. NS had a working capital deficit of $102 million at June 30, 2008, compared with a working capital deficit of $273 million at Dec. 31, 2007; the change was largely the result of increased proceeds from borrowings that were partially used to repurchase shares of Common Stock. The payment of the Avondale Mills settlement affected working capital because the amount subject to arbitration is classified as a long-term receivable. NS' cash, cash equivalents and short-term investment balances totaled $454 million at June 30, 2008. NS expects that cash on hand combined with cash flows from operations will be sufficient to meet its ongoing obligations. In addition to the contractual obligation amounts and information relating to NS' future obligations related to certain tax positions contained in NS' Form 10-K as of Dec. 31, 2007, NS made additional purchase commitments for capital assets, discussed below, and through a private offering issued and sold $600 million in debt securities during the second quarter of 2008.
Cash used for investing activities was $393 million for the first six months of 2008, compared with $385 million in the same period last year, reflecting higher property additions offset in part by increased investment sales net of purchases. In the first quarter of 2008, Norfolk Southern's Board of Directors approved the addition of $64 million to its 2008 capital budget to accelerate the purchase of approximately 750 new coal cars. In July 2008, the Board of Directors authorized the addition of approximately $80 million to the 2008 capital budget, three quarters of which is to acquire new locomotives and the remainder to accelerate program track work.
Cash used for financing activities was $417 million for the first six months of 2008, compared with $880 million for the same period of 2007. The change reflected net debt issuances of $118 million in 2008 compared with debt repayments of $433 million in 2007. Additionally, NS share repurchases for the first six months of 2008 were $67 million higher than for the first six months of 2007. The timing and volume of future share repurchases will be guided by management's assessment of market conditions and other factors. Near-term purchases under the share repurchase program are expected to be made with internally generated cash and proceeds from financings. NS' debt-to-total capitalization ratio was 39.4% at June 30, 2008, compared with 39.6% at Dec. 31, 2007.
NS has in place and available a $1 billion, five-year credit agreement expiring in 2012, which provides for borrowings at prevailing rates and includes financial covenants. There were no amounts outstanding under this facility at June 30, 2008, and NS is in compliance with all of the financial covenants. Through February 2009, NS is ineligible to utilize its March 2001 and September 2004 Form S-3 registration statements due to a late filing of a Form 8-K which was unrelated to its financial condition or results of operations. However, this is not expected to have an impact on financial liquidity. Through a private offering, NS issued and sold $600 million in debt securities in April 2008 (see Note 7), and subsequently exchanged substantially all of these unregistered securities with essentially identical securities registered under the Securities Act of 1933.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions may require significant judgment about matters that are inherently uncertain, and future events are likely to occur that may require management to change them. Accordingly, management regularly reviews these estimates and assumptions based on historical experience, changes in the business environment and other factors that management believes to be reasonable under the circumstances. Management regularly discusses the development, selection and disclosures concerning critical accounting estimates with the Audit Committee of its Board of Directors. There have been no significant changes to the Application of Critical Accounting Estimates disclosure contained in NS' Form 10?K as of Dec. 31, 2007.
OTHER MATTERS
Labor Agreements
Approximately 26,000, or about 85%, of NS' railroad employees are covered by collective bargaining agreements with various labor unions. These agreements remain in effect until changed pursuant to the Railway Labor Act (RLA). NS largely bargains in concert with other major railroads. Moratorium provisions in the labor agreements govern when the railroads and the unions may propose changes.
The most recent bargaining round began in late 2004. Since that time, the railroads have reached agreements that extend through 2009 with all of the major rail unions except the International Association of Machinists (IAM). The unions with which the railroads have reached agreement represent about 95% of NS' unionized employees. A tentative agreement with IAM failed ratification and the parties remain in mediation.
Because NS previously reached separate agreements with the Brotherhood of Locomotive Engineers and Trainmen (BLET) and the American Train Dispatchers Association (ATDA), only the health and welfare provisions from the national agreements will apply to NS' locomotive engineers and ATDA-represented dispatchers. NS also had reached a further tentative agreement that would have extended its contract with BLET through 2014; however, the tentative agreement failed ratification by the employees.
Negotiations with the IAM are being mediated by the National Mediation Board (NMB), a federal agency. The status quo is preserved during mediation (that is, the union may not strike and management may not change the labor agreement) while the NMB assists the parties in their efforts to reach agreement. If the NMB were to terminate mediation, it would, at that time, propose that the parties arbitrate their differences. A strike could occur 30 days thereafter if the parties did not accept arbitration. However, the President of the United States of America could then appoint an Emergency Board, which would delay any strike for a further 60 days while the Board made recommendations and the parties engaged in further negotiations. The outcome of the negotiations cannot be determined at this time.
Market Risks and Hedging Activities
NS uses derivative financial instruments to manage its overall exposure to fluctuations in interest rates. NS manages its overall exposure to fluctuations in interest rates by issuing both fixed- and floating-rate debt instruments, and by entering into interest-rate hedging transactions to achieve an appropriate mix within its debt portfolio.
At June 30, 2008, NS' debt subject to interest rate fluctuations totaled $124 million. A 1% increase in interest rates would increase NS' total annual interest expense related to all its variable debt by approximately $1 million. Management considers it unlikely that interest rate fluctuations applicable to these instruments will result in a material adverse effect on NS' financial condition, results of operations or liquidity.
Some of NS' capital leases, which carry an average fixed rate of 7%, were effectively converted to variable rate obligations using interest rate swap agreements. On June 30, 2008, the average pay rate under these agreements was 4%, and the average receive rate was 7%. The effect of the swaps was to reduce interest expense by less than $1 million in the second quarters of 2008 and 2007. A portion of the lease obligations is payable in Japanese yen. NS eliminated the associated exchange rate risk at the inception of each lease with a yen deposit sufficient to fund the yen-denominated obligation. Most of these deposits are held by foreign banks, primarily Japanese. As a result, NS is exposed to financial market risk relative to Japan. Counterparties to the interest rate swaps and Japanese banks holding yen deposits are major financial institutions believed by management to be creditworthy.
Environmental Matters
NS is subject to various jurisdictions' environmental laws and regulations. It is NS' policy to record a liability where such liability or loss is probable and its amount can be estimated reasonably. Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables (when collection is probable) in the Consolidated Balance Sheets and are not netted against the associated NS liability. Environmental engineers regularly participate in ongoing evaluations of all known sites and in determining any necessary adjustments to liability estimates. NS also has an Environmental Policy Council, composed of senior managers, to oversee and interpret its environmental policy.
NS' Consolidated Balance Sheets include liabilities for environmental exposures in the amount of $39 million at June 30, 2008, and $46 million at Dec. 31, 2007 (of which $12 million is classified as a current liability at the end of each period). At June 30, 2008, the liability represents NS' estimate of the probable cleanup and remediation costs based on available information at 152 known locations. As of that date, 11 sites account for $19 million of the liability, and no individual site was considered to be material. NS anticipates that much of this liability will be paid out over five years; however, some costs will be paid out over a longer period.
At 30 locations, one or more subsidiaries of NS, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs.
With respect to known environmental sites (whether identified by NS or by the . . .
|
|