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| NSC > SEC Filings for NSC > Form 10-Q on 3-Aug-2009 | All Recent SEC Filings |
3-Aug-2009
Quarterly Report
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes.
OVERVIEW
NS' second quarter 2009 results were impacted by the substantially weakened economy as net income declined 45% compared with the same period last year. A 26% decrease in volumes coupled with lower fuel surcharge revenue more than offset the effects of expense reductions and rate increases. Operating expenses declined 29%, compared with the same period last year, primarily due to lower fuel and compensation and benefits costs. The railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) rose to 74.8% compared with 71.1% for the second quarter of 2008.
Cash provided by operating activities for the first six months was $643 million and, along with proceeds from borrowings, provided for debt maturities, capital expenditures, and dividends. At June 30, 2009, cash and short-term investment balances totaled $722 million.
SUMMARIZED RESULTS OF OPERATIONS
Second quarter 2009 net income was $247 million, down $206 million, or 45%, compared with the same period last year. The reduction primarily resulted from a $331 million decrease in income from railway operations that reflected a $908 million, or 33%, decline in railway operating revenues, partially offset by a $577 million, or 29%, decrease in railway operating expenses.
For the first six months of 2009, net income was $424 million, down $320 million, or 43%, compared with the same period last year. Income from railway operations decreased $526 million, as a $1.5 billion decline in railway operating revenues was partially offset by a $939 million drop in railway operating expenses and a $215 million decrease in income taxes.
Oil prices affect NS' results of operations in a variety of ways and can have an overall favorable or unfavorable impact in any particular period. In addition to the impact of oil prices on general economic conditions, traffic volume, and supplier costs, oil prices directly affect NS' revenues through market-based fuel surcharges and contract escalators (see "Railway Operating Revenues") and also affect fuel costs (see "Railway Operating Expenses"). For the second quarter and first six months of 2009, excluding the impact of decreased consumption, the decline in fuel surcharge revenue was greater than the decline in fuel expense. Future changes in oil prices may cause volatility in operating results that could be material to a particular period.
DETAILED RESULTS OF OPERATIONS
Railway Operating Revenues
Second quarter 2009 railway operating revenues were $1.9 billion, down $908 million, or 33%, compared with the second quarter of 2008. For the first six months, railway operating revenues were $3.8 billion, down $1.5 billion, or 28%. As shown in the following table, the decreases were the result of lower traffic volumes and lower average revenue per unit which was driven by lower fuel surcharges that more than offset rate increases. Fuel surcharges amounted to $62 million in the second quarter (down $348 million) and $156 million for the first six months (down $574 million).
Second Quarter First Six Months
2009 vs. 2008 2009 vs. 2008
Decrease Decrease
($ in millions) ($ in millions)
Traffic volume (units) $ (711) $ (1,216)
Revenue per unit/mix (197) (249)
Total $ (908) $ (1,465)
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Many of Norfolk Southern's negotiated fuel surcharges for coal and general merchandise traffic are based on the monthly average price of West Texas Intermediate Crude Oil (WTI Average Price). These surcharges are reset the first day of each calendar month based on the WTI Average Price for the second preceding calendar month. This two month lag in computing WTI Average Price coupled with the change in fuel prices lowered fuel surcharge revenue of approximately $35 million for the quarter and $25 million for the first six months.
Revenues, units and average revenue per unit for NS' market groups were as follows:
Second Quarter
Revenues Units Revenue per Unit
2009 2008 2009 2008 2009 2008
($ in millions) (in thousands) ($ per unit)
Coal $ 511 $ 775 331.9 448.3 $ 1,538 $ 1,729
General merchandise:
Agriculture/consumer/gov't 287 326 135.0 156.6 2,125 2,077
Metals/construction 171 352 117.2 210.4 1,460 1,675
Chemicals 245 322 80.5 103.9 3,047 3,095
Paper/clay/forest 165 231 74.0 102.4 2,239 2,261
Automotive 110 227 60.9 116.3 1,798 1,954
General merchandise 978 1,458 467.6 689.6 2,093 2,115
Intermodal 368 532 612.8 763.1 600 698
Total $ 1,857 $ 2,765 1,412.3 1,901.0 $ 1,315 $ 1,455
First Six Months
Revenues Units Revenue per Unit
2009 2008 2009 2008 2009 2008
($ in millions) (in thousands) ($ per unit)
Coal $ 1,113 $ 1,437 712.7 875.3 $ 1,561 $ 1,642
General merchandise:
Agriculture/consumer/gov't 565 625 265.4 308.7 2,127 2,023
Metals/construction 354 657 238.1 396.9 1,488 1,657
Chemicals 481 627 160.8 206.1 2,994 3,041
Paper/clay/forest 331 446 148.6 202.6 2,230 2,201
Automotive 222 455 122.7 235.9 1,808 1,930
General merchandise 1,953 2,810 935.6 1,350.2 2,088 2,081
Intermodal 734 1,018 1,219.6 1,503.5 602 677
Total $ 3,800 $ 5,265 2,867.9 3,729.0 $ 1,325 $ 1,412
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Coal
Coal revenues decreased $264 million, or 34%, in the second quarter and $324 million, or 23%, in the first six months, compared with the same periods last year. Both declines reflect lower traffic volumes (down 26% for the quarter and 19% for the first six months). Average revenue per unit declined 11% in the second quarter and 5% in the first six months, as lower fuel surcharges more than offset higher rates. For both periods, tonnage handled decreased in all coal markets. Coal tonnage by market was as follows:
Total Coal, Coke, and Iron Ore Tonnage
Second Quarter First Six Months
2009 2008 2009 2008
(tons in thousands)
Utility 30,595 36,072 63,966 71,676
Export 2,362 6,201 6,743 11,974
Domestic metallurgical 2,363 4,745 4,973 8,262
Industrial 1,849 2,250 3,698 4,159
37,169 49,268 79,380 96,071
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Utility coal tonnage decreased 15% in the second quarter and 11% in the first six months as a result of lower demand for electricity induced by the downturn in the U.S. economy and natural gas competition. Export coal tonnage decreased 62% in the second quarter and 44% in the first six months, reflecting the decline in global steel production as a result of the continued weakness in the global economy. Domestic metallurgical coal, coke, and iron ore tonnage was down 50% in the second quarter and 40% in the first six months, as domestic steel production declined due to a drop in steel demand. Other coal tonnage (principally steam coal shipped to industrial plants) decreased 18% in the second quarter and 11% in the first six months, principally due to reduced production at NS-served plants.
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. In April 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 a notice of appeal, and oral argument was held before the Virginia Supreme Court in April 2009. 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.
NS is currently involved in litigation with a coal customer to enforce provisions of a transportation contract related to reimbursement of certain infrastructure expenses incurred by NS and minimum tonnage commitments and related deficit charges. NS has recorded receivables totaling $46 million associated with this contract and believes that collection of such amounts is probable; however, an unfavorable decision in the event of trial could have an adverse impact on results of operations in a particular year or quarter.
Coal revenues for the remainder of the year are expected to remain below those of last year due to continued weak volumes and lower fuel surcharge revenue.
General Merchandise
General merchandise revenues decreased $480 million, or 33%, in the second quarter, compared with the same period last year, reflecting a 32% decline in traffic volumes and a 1% decrease in average revenue per unit. For the first six months, general merchandise revenues decreased $857 million, or 30%, reflecting a 31% decline in traffic volumes and relatively flat average revenue per unit, despite the impact of lower fuel surcharges.
Agriculture, consumer products, and government volumes decreased 14% for both periods, reflecting declines in fertilizer, corn, soybeans, and wheat shipments principally due to processing and production cutbacks. Metals and construction volumes were down 44% in the second quarter and 40% for the first six months, reflecting reduced shipments of coil, scrap metals, steel, and iron and reduced demand for construction materials due to the weak housing and automotive sectors. Chemicals traffic volumes decreased 23% for the second quarter and 22% for the first six months, a result of continued weakness in industrial intermediates (linked to housing construction declines), as well as fewer shipments of petroleum-based products, plastics, and miscellaneous chemicals. Paper, clay, and forest products volumes were down 28% for the second quarter and 27% for the first six months, reflecting reduced U.S. paper production and lower volumes related to the slowdown in the housing market. Automotive volumes decreased 48% for both periods, a result of lower North American sales and production. Automotive manufacturers, especially the domestic producers, continued to experience significant sales declines. North American light vehicle production decreased by 52% during the quarter and 50% for the first six months as manufacturers cut production in line with consumer demand. During the second quarter of 2009, General Motors and Chrysler each entered into bankruptcy proceedings, subsequent to which their respective viable assets were sold to and began being operated by new entities (colloquially referred to as "new General Motors" and "new Chrysler"). The results of these proceedings did not have a material adverse effect on NS' financial position, results of operations, or liquidity during the second quarter nor does NS expect these proceedings will have a material adverse effect on NS' financial position, results of operations, or liquidity in future periods. During the second quarter, Ford, General Motors, and Chrysler combined operated 15 of 25 assembly plants served by NS. NS continues to monitor the state of the automotive industry and collectability of associated receivables.
General merchandise revenues for the remainder of the year are expected to be lower than 2008, reflecting lower volumes and fuel surcharge revenue.
Intermodal
Intermodal revenues decreased $164 million, or 31%, in the second quarter, and $284 million, or 28%, for the first six months, compared with the same periods last year, reflecting lower traffic volumes (down 20% and 19%, respectively) and decreased average revenue per unit (down 14% and 11%, respectively), including the impact of lower fuel surcharge revenue.
Domestic volumes (which include truckload and intermodal marketing companies'
[IMC] volumes) decreased 2% in the second quarter, but were flat for the first
six months. International traffic volumes declined 34% for the quarter and 33%
for the first six months, primarily driven by the weak global economy. The
Premium business, which includes parcel and less-than-truckload (LTL) carriers,
decreased 18% for both periods due to poor economic conditions and fewer empty
repositions. Triple Crown Services Company, a service with rail-to-highway
trailers, experienced volume declines of 17% for the second quarter and 16% for
the first six months, primarily driven by reduced auto parts shipments and the
weak economy.
Intermodal revenues for the remainder of the year are expected to continue to be lower than those of last year reflecting lower volumes and fuel surcharge revenue.
Railway Operating Expenses
Second quarter railway operating expenses were $1.4 billion in 2009, down $577 million, or 29%, compared with the same period last year. For the first six months, expenses were $2.9 billion, down $939 million, or 24%.
Compensation and benefits expenses decreased $111 million, or 17%, in the second quarter and $177 million, or 13%, in the first six months, compared with the same periods last year. The decreases were primarily the result of lower volume-related payroll (down $66 million for the second quarter and $113 million for the first six months), stock-based and incentive compensation (down $58 million for the quarter and $114 million for the first six months), and payroll taxes (down $13 million for the quarter and $15 million for the first six months). These decreases were partially offset by increased wage rates (up $12 million for the second quarter and $25 million for the first six months), pension expenses (up $11 million for the second quarter and $21 million for the first six months), and medical benefits for active and retired employees (up $7 million for the second quarter and $17 million for the first six months).
Purchased services and rents decreased $66 million, or 17%, for the second quarter and $86 million, or 11%, for the first six months, compared with the same periods last year. The decreases were primarily driven by lower volume-related intermodal and transportation services costs (including automotive related costs and crew transportation expenses), equipment rents, and mechanical expenses.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, decreased $338 million, or 69%, for the second quarter, and $583 million, or 65%, for the first six months, compared with the same periods last year. The declines were principally the result of lower fuel prices (locomotive prices down 57% and 54%, respectively), which had an impact of $212 million in the second quarter and $387 million for the first six months, and reduced fuel consumption (locomotive consumption down 26% and 23%, respectively), which had an impact of $126 million and $196 million, respectively.
Depreciation expense increased $8 million, or 4%, for the second quarter and $17 million, or 4%, for the first six months, compared to the same periods last year, reflecting an increased capital base.
Materials and other expenses (including the estimates of costs related to personal injury, property damage, and environmental matters) decreased $70 million, or 33%, in the second quarter and $110 million, or 24%, for the first six months, compared with the same periods last year. The decreases reflected a $21 million favorable adjustment related to settlement of a multi-year state tax dispute, lower costs associated with derailments, decreased freight car and locomotive material expenses, favorable personal injury claims development and employee travel costs offset in part by higher environmental remediation costs. The first six months also reflected the absence of the 2008 Avondale Mills settlement related to the Graniteville accident (see additional discussion below). The following table shows the components of materials and other expenses:
Second Quarter First Six Months
2009 2008 2009 2008
($ in millions)
Materials $ 76 $ 96 $ 165 $ 197
Casualties and other claims 21 42 57 107
Other 47 76 122 150
$ 144 $ 214 $ 344 $ 454
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In April 2008, NS settled the lawsuit brought by Avondale Mills for claims
associated with the January 6, 2005, derailment in Graniteville, South Carolina.
A portion of the settlement was not 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 long-term
receivables for estimated recoveries from NS' insurance carriers. NS is
engaged in arbitration with one of its insurance carriers that failed to respond
to an insurance claim submitted by NS. NS believes these expenses are covered
by the insurance policy and that recovery of the contested amount is probable,
in that NS expects the arbitrator will 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. Accordingly, NS has recorded the full
recovery attributable to such carrier ($100 million). In October 2008, another
of NS' insurance carriers provided the preliminary findings of its review of NS'
reimbursement request and reported that it may dispute a portion of that
request. NS has initiated arbitration against the carrier and believes that
all expenses contained in the reimbursement request are covered by the insurance
policy and that recovery is probable.
Other Income - Net
Other income - net decreased $10 million in the second quarter but was flat for
the first six months of 2009 compared with the same periods in 2008. Both
periods reflect fewer gains on the sale of property (down $15 million for the
quarter and $18 million for the first six months), increased interest expense
(net) on tax deficiencies (up $4 million for the quarter and $3 million for the
first six months - including the second quarter effects of the 2009 and 2008
favorable resolutions of prior years' tax matters), and lower interest income
(down $2 million for the quarter and $4 million for the first six months).
These declines were partially offset by higher net returns from corporate-owned
life insurance (up $14 million for the quarter and $22 million for the first six
months).
Provision for Income Taxes
The second quarter and year-to-date effective income tax rates were 36.8% and 37.1% in 2009, respectively, compared with 38.2% and 38.5%, respectively, for the same periods last year. The decreases were largely due to improved net returns from corporate-owned life insurance.
NS' consolidated income tax returns for 2006 and 2007 are being audited by the Internal Revenue Service and these audits are expected to be completed by year end. NS does not expect that the resolution of the examination will have a material effect on its financial position, results of operations, or liquidity.
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities, NS' principal source of liquidity, was $643 million for the first six months of 2009. NS had working capital of $198 million at June 30, 2009, compared with a working capital deficit of $106 million at December 31, 2008; the change was largely due to an increase in cash and cash equivalents, reflecting the absence of share repurchase activity and higher borrowings net of repayments during the first six months of 2009, in addition to lower current tax liabilities resulting from the decline in taxable income during the period. NS' cash and cash equivalents totaled $722 million at June 30, 2009. 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 contained in NS' Form 10-K for the year ended December 31, 2008, NS (1) issued $500 million of 5.90% unsecured notes and $500 million of 5.75% unsecured notes, (2) paid off $400 million of 6.20% senior notes upon maturity and repaid $200 million under its accounts receivable securitization facility and, (3) issued $75 million in non-interest bearing notes payable with maturity dates beginning in 2010 and ending in 2012 (the "Pan Am Notes") as part of its investment in Pan Am Southern LLC (see discussions below). There were no material changes to the information on NS' future obligations related to uncertain tax positions contained in NS' Form 10-K for the year ended December 31, 2008.
Cash used for investing activities was $649 million in the first six months of 2009, compared with $393 million in the same period last year, reflecting lower investment sales and higher investment purchases offset in part by lower property additions. Budgeted capital expenditures for 2009 are approximately $1.3 billion.
During the second quarter, NS and Pan Am Railways, Inc. (Pan Am) formed a joint venture, Pan Am Southern LLC (PAS), a railroad company in which each has a 50% equity interest. Pan Am contributed to PAS a 155-mile main line track that runs between Mechanicville, New York and Ayer, Massachusetts, along with 281 miles of secondary and branch lines, including trackage rights in New York, Connecticut, Massachusetts, New Hampshire, and Vermont (collectively, the "PAS Lines"), and NS has contributed cash and other property with a combined value of approximately $60 million (of which $55 million was contributed during the second quarter) and committed to contribute an additional $80 million in cash and other property over the next three years, $75 million of which is evidenced by the Pan Am Notes. A significant portion of NS' contributions will be used for capital improvements to the PAS Lines and the related construction of new intermodal and automotive terminals in the Albany, New York and the Ayer, Massachusetts areas. PAS is jointly controlled by NS and Pan Am, accordingly NS will account for its interest in PAS using the equity method of accounting.
Cash provided by financing activities was $110 million in the first six months of 2009, compared with a use of $417 million for the first six months of 2008. The change reflected the absence of share repurchase activity during the period and higher borrowings net of debt repayments that were offset in part by fewer exercises of employee stock options and increased dividend payments. Due to current economic and market conditions, the amount of future share repurchases is uncertain and the timing and volume of such future share repurchases will be guided by management's assessment of market conditions and other pertinent factors. NS' debt-to-total capitalization ratio was 41.8% at June 30, 2009, compared with 41.0% at December 31, 2008.
In June 2009, NS issued $500 million of unsecured notes at 5.90% due 2019
pursuant to its automatic shelf registration statement described below (see Note
7). The net proceeds from the offering were $496 million after deducting the
purchase discount and expenses.
In January 2009, through a private offering, NS issued $500 million of unsecured notes at 5.75% due 2016. The net proceeds from the offering were $494 million after deducting the purchase discount and expenses. NS has agreed to exchange the unregistered securities with essentially identical securities registered under the Securities Act of 1933.
NS has authority from its board of directors to issue an additional $500 million of debt or equity securities through public or private sale. As of June 30, 2009, NS has on file with the Securities and Exchange Commission a Form S-3 automatic shelf registration statement for well-known seasoned issuers under which up to $500 million could be issued under this authority.
NS also has in place and available a $1 billion, five-year credit agreement expiring in 2012, which provides for borrowings at prevailing rates and includes covenants. NS had no amounts outstanding under this facility at June 30, 2009, and NS is in compliance with all of its covenants. NS also has an accounts receivable securitization program with a 364-day term expiring in October 2009 with $100 million outstanding at June 30, 2009 (see Note 7).
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 make changes to these estimates and assumptions. 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 . . .
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