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| NSC > SEC Filings for NSC > Form 10-Q on 30-Oct-2009 | All Recent SEC Filings |
30-Oct-2009
Quarterly Report
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes.
OVERVIEW
NS' third quarter 2009 net income declined 42% compared with the same period last year, reflecting the ongoing weakened economy. Despite this decline, NS continues to focus on safety, service, and asset management to strategically position itself for the long term. A 20% decrease in volumes coupled with lower fuel surcharge revenue more than offset the effects of expense reductions and rate increases. Operating expenses declined 25%, compared with the same period last year, primarily due to reduced volume-related expenses and lower fuel prices. The railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) rose to 72.8% compared with 69.1% for the third quarter of 2008.
Cash provided by operating activities for the first nine months was $1.4 billion and, along with proceeds from borrowings, provided for capital expenditures, debt maturities, and dividends. At September 30, 2009, cash and cash equivalents totaled $999 million.
SUMMARIZED RESULTS OF OPERATIONS
Third quarter 2009 net income was $303 million, down $217 million, or 42%, compared with the same period last year. The reduction primarily resulted from a $332 million decrease in income from railway operations that reflected an $831 million, or 29%, decline in railway operating revenues, and a $499 million, or 25%, decrease in railway operating expenses.
For the first nine months of 2009, net income was $727 million, down $537 million, or 42%, compared with the same period last year. Income from railway operations decreased $858 million, as a $2.3 billion decline in railway operating revenues was partially offset by a $1.4 billion drop in railway operating expenses.
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 third quarter and first nine 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
Third quarter 2009 railway operating revenues were $2.1 billion, down $831 million, or 29%, compared with the third quarter of 2008. For the first nine months, railway operating revenues were $5.9 billion, down $2.3 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 $99 million in the third quarter (down $436 million) and $255 million for the first nine months (down $1 billion).
Third Quarter First Nine Months
2009 vs. 2008 2009 vs. 2008
Decrease Decrease
($ in millions) ($ in millions)
Traffic volume (units) $ (570) $ (1,791)
Revenue per unit/mix (261) (505)
Total $ (831) $ (2,296)
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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 by approximately $10 million for the quarter and $35 million for the first nine months.
Revenues, units and average revenue per unit for NS' market groups were as follows:
Third Quarter
Revenues Units Revenue per Unit
2009 2008 2009 2008 2009 2008
($ in millions) (in thousands) ($ per unit)
Coal $ 571 $ 876 351.3 450.9 $ 1,627 $ 1,941
General merchandise:
Agriculture/consumer/gov't 296 338 141.6 158.6 2,097 2,136
Metals and construction 205 357 139.4 203.7 1,471 1,752
Chemicals 297 337 95.9 103.0 3,090 3,275
Paper/clay/forest 169 241 79.3 101.5 2,123 2,376
Automotive 136 185 74.6 86.7 1,825 2,125
General merchandise 1,103 1,458 530.8 653.5 2,078 2,232
Intermodal 389 560 640.1 790.9 608 708
Total $ 2,063 $ 2,894 1,522.2 1,895.3 $ 1,355 $ 1,527
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First Nine Months
Revenues Units Revenue per Unit
2009 2008 2009 2008 2009 2008
($ in millions) (in thousands) ($ per unit)
Coal $ 1,684 $ 2,313 1,064.0 1,326.2 $ 1,583 $ 1,744
General merchandise:
Agriculture/consumer/gov't 861 963 407.0 467.3 2,117 2,062
Metals and construction 559 1,014 377.5 600.6 1,482 1,689
Chemicals 778 964 256.7 309.1 3,030 3,119
Paper/clay/forest 500 687 227.9 304.1 2,193 2,259
Automotive 358 640 197.3 322.6 1,814 1,983
General merchandise 3,056 4,268 1,466.4 2,003.7 2,084 2,130
Intermodal 1,123 1,578 1,859.7 2,294.4 604 688
Total $ 5,863 $ 8,159 4,390.1 5,624.3 $ 1,336 $ 1,451
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Coal
Coal revenues decreased $305 million, or 35%, in the third quarter and $629 million, or 27%, in the first nine months, compared with the same periods last year. Both declines reflect lower traffic volumes (down 22% for the quarter and 20% for the first nine months). Average revenue per unit declined 16% in the third quarter and 9% in the first nine 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
Third Quarter First Nine Months
2009 2008 2009 2008
(tons in thousands)
Utility 29,146 35,902 93,112 107,578
Export 4,795 6,262 11,538 18,236
Domestic metallurgical 3,232 5,241 8,205 13,503
Industrial 1,885 2,271 5,583 6,430
39,058 49,676 118,438 145,747
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Utility coal tonnage decreased 19% in the third quarter and 13% in the first nine months as a result of the continued lower demand for electricity induced by the downturn in the U.S. economy, in addition to natural gas competition. Export coal tonnage decreased 23% in the third quarter and 37% in the first nine months, reflecting the decline in European steel production as a result of continued weakness in the global economy. However, steel production improvements in China generated new export coal tonnage business. Domestic metallurgical coal, coke, and iron ore tonnage was down 38% in the third quarter and 39% in the first nine months, as domestic steel production declined due to a drop in steel demand. Other coal tonnage (principally steam coal shipped to industrial plants) decreased 17% in the third quarter and 13% in the first nine 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. The Virginia Supreme Court announced its decision on September 18, 2009, which was generally favorable to NS, but substantially reduced the damages which had been awarded by the trial court. Both parties have filed Petitions for Rehearing; however, NS does not believe the outcome will have a material effect on NS' financial condition, results of operations, or liquidity.
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 $52 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 fourth quarter 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 $355 million, or 24%, in the third quarter, compared with the same period last year, reflecting a 19% decline in traffic volumes and a 7% decrease in average revenue per unit, including the impact of lower fuel surcharges. For the first nine months, general merchandise revenues decreased $1.2 billion, or 28%, reflecting a 27% decline in traffic volumes and 2% decrease in average revenue per unit.
Agriculture, consumer products, and government volumes decreased 11% in the third quarter and 13% for the first nine months, primarily driven by declines in fertilizer, corn, and soybean shipments principally due to processing and production cutbacks. Metals and construction volumes were down 32% in the third quarter and 37% for the first nine months, reflecting reduced shipments of coil, scrap metals, and iron and steel, in addition to reduced demand for construction materials due to the weak housing, infrastructure, and automotive sectors. Chemicals traffic volumes decreased 7% for the third quarter and 17% for the first nine months. Both periods reflect continued weakness in industrial intermediates (linked to housing construction declines), as well as fewer shipments of plastics and miscellaneous chemicals, while the first nine months also included fewer shipments of petroleum-based products. Paper, clay, and forest products volumes were down 22% for the third quarter and 25% for the first nine months, reflecting lower pulpboard, lumber, kaolin, and printing paper shipments due to reduced U.S. paper production and the slowdown in the housing market. Automotive volumes decreased 14% in the third quarter and 39% for the first nine months, a result of lower production. North American light vehicle production decreased by 23% during the quarter and 42% for the first nine months as manufacturers cut production in line with consumer demand.
General merchandise revenues for the fourth quarter are expected to be lower than 2008, reflecting lower volumes and fuel surcharge revenue.
Intermodal
Intermodal revenues decreased $171 million, or 31%, in the third quarter, and $455 million, or 29%, for the first nine months, compared with the same periods last year, reflecting lower traffic volumes (down 19% for both periods) and decreased average revenue per unit (down 14% and 12%, respectively), including the impact of lower fuel surcharge revenue.
Domestic volumes (which include truckload and intermodal marketing companies'
[IMC] volumes) decreased 6% in the third quarter and 3% for the first nine
months reflecting weakness in the economy. International traffic volumes
declined 32% for both periods, primarily driven by the weak U.S. import and
export markets. The Premium business, which includes parcel and
less-than-truckload (LTL) carriers, decreased 17% for the quarter and 18% for
the first nine months due to poor economic conditions. Triple Crown Services
Company, a service with rail-to-highway trailers, experienced volume declines of
4% for the third quarter and 12% for the first nine months, primarily driven by
reduced auto parts shipments and the weak economy.
Intermodal revenues for the remainder of the year are expected to be lower than those of last year reflecting lower volumes and fuel surcharge revenue.
Railway Operating Expenses
Third quarter railway operating expenses were $1.5 billion in 2009, down $499 million, or 25%, compared with the same period last year. For the first nine months, expenses were $4.5 billion, down $1.4 billion, or 24%.
Compensation and benefits expenses decreased $110 million, or 16%, in the third quarter and $287 million, or 14%, in the first nine months, compared with the same periods last year. The decreases were primarily the result of lower volume-related payroll (down $64 million for the third quarter and $177 million for the first nine months), reduced incentive and stock-based compensation (down $33 million for the quarter and $147 million for the first nine months), the absence of the cost of lump-sum payments due under the 2008 Brotherhood of Locomotive Engineers and Trainmen (BLET) agreement ($28 million), and lower payroll taxes (down $8 million for the quarter and $23 million for the first nine months). These decreases were partially offset by increased wage rates (up $14 million for the third quarter and $39 million for the first nine months), pension expenses (up $11 million for the third quarter and $32 million for the first nine months), and medical benefits for active and retired employees (up $6 million for the third quarter and $23 million for the first nine months). NS expects health and welfare benefit premiums for agreement employees covered by multi-employer plans will increase by approximately $56 million for 2010. The increase in these premiums, which are established under the provisions of national labor agreements, will occur next year reflecting higher-than-anticipated demand and lower-than-anticipated funding due to the industry's heavy 2009 furloughs.
Purchased services and rents decreased $67 million, or 16%, for the third quarter and $153 million, or 13%, for the first nine months, compared with the same periods last year. The decreases were primarily driven by lower volume-related expenses such as transportation services and operations (including automotive related costs and crew transportation expenses), intermodal costs, equipment rents, and engineering services and mechanical expenses (largely because of reduced maintenance activities). These declines were offset in part by increased legal fees.
Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, decreased $282 million, or 59%, for the third quarter, and $865 million, or 63%, for the first nine months, compared with the same periods last year. The declines were principally the result of lower fuel prices (locomotive fuel prices down 48% and 52%, respectively), which had an impact of $190 million in the third quarter and $577 million for the first nine months, and reduced fuel consumption (locomotive fuel consumption down 19% and 22%, respectively), which had an impact of $92 million and $288 million, respectively.
Depreciation expense increased $9 million, or 4%, for the third quarter and $26 million, or 4%, for the first nine months, compared to the same periods last year, reflecting an increased capital base as NS continues to invest in its infrastructure and equipment.
Materials and other expenses (including the estimates of costs related to personal injury, property damage, and environmental matters) decreased $49 million, or 25%, in the third quarter and $159 million, or 24%, for the first nine months, compared with the same periods last year. The decreases reflect lower locomotive, freight car, and engineering material expenses, lower loss and damage claims, and reduced employee travel costs. The first nine months also reflected a $21 million favorable adjustment related to settlement of a multi-year state tax dispute, the absence of the 2008 Avondale Mills settlement related to the Graniteville accident (see additional discussion
below), and favorable personal injury claims development, offset in part by higher environmental remediation costs. The following table shows the components of materials and other expenses:
Third Quarter First Nine Months
2009 2008 2009 2008
($ in millions)
Materials $ 72 $ 96 $ 237 $ 293
Casualties and other claims 23 34 80 141
Other 54 68 176 218
$ 149 $ 198 $ 493 $ 652
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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 has submitted
its arbitration claim ($43 million). NS believes that recovery of the claimed
amount is probable.
Other Income - Net
Other income - net decreased $2 million in both the third quarter and the first nine months of 2009 compared with the same periods in 2008. Both periods reflect higher interest expense (net) on tax deficiencies (up $7 million for the quarter and $10 million for the first nine months, which includes the effects of the second quarter 2009 and 2008 favorable resolutions of prior years' tax matters), and lower interest income (down $2 million for the quarter and $6 million for the first nine months). These declines were partially offset by higher net returns from corporate-owned life insurance (up $7 million for the quarter and $29 million for the first nine months). The quarter also reflects more gains on the sale of property (up $7 million), whereas the first nine months reflect fewer gains on the sale of property (down $11 million).
Provision for Income Taxes
The third quarter and year-to-date effective income tax rates were 37.0% and 37.1% in 2009, respectively, compared with 36.7% and 37.8%, respectively, for the same periods last year.
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 $1.4 billion for the first nine months of 2009 compared with $2.1 billion for the same period of 2008, primarily reflecting lower income from railway operations. NS had working capital of $367 million at September 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 nine months of 2009. NS' cash and cash equivalents totaled $999 million at September 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 $967 million in the first nine months of 2009, compared with $810 million in the same period last year, reflecting lower proceeds from investment sales and higher investment purchases offset in part by lower property additions. NS expects total capital expenditures for 2009 to be approximately $1.4 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 as of September 30, 2009, NS has contributed cash and other property with a combined value of approximately $63 million and committed to contribute an additional $77 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 accounts for its interest in PAS using the equity method of accounting.
Cash used for financing activities was $27 million in the first nine months of 2009, compared with $914 million for the same period 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 41.2% at September 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. During the third quarter of 2009, NS offered 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 September 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 September 30, 2009, and NS is in compliance with all of its covenants. In October 2009, NS renewed and amended its accounts receivable securitization program with a 364-day term to run until October 2010. NS reduced the total amount that can be borrowed from $500 million to $350 million to more closely match its liquidity requirements and receivables profile. There was $100 million outstanding under this program at September 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 . . .
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