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NSC > SEC Filings for NSC > Form 10-K on 14-Feb-2014All Recent SEC Filings

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Form 10-K for NORFOLK SOUTHERN CORP


14-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Norfolk Southern Corporation and Subsidiaries
Management's Discussion and Analysis of
Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes and the Selected Financial Data.

OVERVIEW

We are one of the nation's premier transportation companies. Our Norfolk Southern Railway Company subsidiary operates approximately 20,000 miles of road in 22 states and the District of Columbia, serves every major container port in the eastern United States, and provides efficient connections to other rail carriers. We operate the most extensive intermodal network in the East and are a major transporter of coal, automotive, and industrial products.

Our net income increased 9% in 2013, compared with 2012, and earnings per share improved 12%, reflecting improved operating results, a large gain from a nonoperating transaction, and share repurchases. Higher revenues and increased network efficiencies improved our railway operating ratio (a measure of the amount of operating revenues consumed by operating expenses) from 71.7% in 2012 to 71.0% in the current year.

Cash provided by operating activities totaled $3.1 billion, which along with proceeds from borrowings and cash on hand, allowed for property additions, dividends, share repurchases, and debt repayments. During 2013, we repurchased 8.3 million shares of Common Stock at a total cost of $627 million. Since inception of our stock repurchase program in 2006, we have repurchased and retired 136.7 million shares of Common Stock at a total cost of $8.1 billion. At December 31, 2013, cash, cash equivalents, and short-term investments totaled $1.6 billion.

In 2014, we expect revenues to increase, reflecting higher volumes. We will continue to focus on safety, cost control, productivity, service levels, operational efficiency, and an ongoing market-based approach to pricing.

K21

SUMMARIZED RESULTS OF OPERATIONS

2013 Compared with 2012

Net income in 2013 was $1.9 billion, or $6.04 per diluted share, up $161 million, or 9%, compared with $1.7 billion, or $5.37 per diluted share, in 2012, a reflection of a 4% increase in income from railway operations, in addition to the favorable impact of the recognition of the gain from the sale of certain assets to the Michigan Department of Transportation (MDOT), which benefited net income by $60 million and earnings per share by $0.19. Railway operating revenues rose 2%, while operating expenses increased 1%, driven largely by higher volume-related expenses.

2012 Compared with 2011

Net income in 2012 was $1.7 billion, or $5.37 per diluted share, down $167 million, or 9%, compared with

$1.9 billion, or $5.45 per diluted share, in 2011. The decrease in net income was due to lower income from railway operations, lower nonoperating income items, higher interest expense on debt, and a higher effective income tax rate (Note 3). Railway operating revenues decreased modestly, $132 million, reflecting lower average revenue per unit, including fuel surcharges. Railway operating expenses also decreased modestly, $43 million, largely driven by the absence of the $58 million unfavorable arbitration ruling in 2011 and declines related to network efficiency and productivity gains, offset by higher depreciation and intermodal volume-related expenses.

DETAILED RESULTS OF OPERATIONS



Railway Operating Revenues



Railway operating revenues were $11.2 billion in 2013, $11.0 billion in 2012,
and $11.2 billion in 2011. The following table presents a three-year comparison
of revenues, volumes, and average revenue per unit by market group.



                                 Revenues                            Units                       Revenue per Unit
                       2013        2012        2011        2013       2012       2011       2013       2012       2011
                               ($ in millions)                    (in thousands)                 ($ per unit)

Coal                 $  2,543    $  2,879    $  3,458    1,346.7    1,414.1    1,619.6    $ 1,888    $ 2,036    $ 2,135
General merchandise:
Chemicals               1,667       1,467       1,368      449.2      388.8      373.7      3,711      3,772      3,662
Agr./consumer/gov't.    1,467       1,446       1,439      594.3      595.9      599.4      2,468      2,427      2,400
Metals/construction     1,405       1,335       1,241      666.9      669.7      665.0      2,106      1,993      1,867
Automotive                984         897         780      402.1      374.6      332.2      2,448      2,395      2,348
Paper/clay/forest         795         775         756      309.4      305.8      314.3      2,570      2,536      2,404
General merchandise     6,318       5,920       5,584    2,421.9    2,334.8    2,284.6      2,609      2,536      2,444

Intermodal              2,384       2,241       2,130    3,572.3    3,358.3    3,210.5        667        667        663

  Total              $ 11,245    $ 11,040    $ 11,172    7,340.9    7,107.2    7,114.7    $ 1,532    $ 1,553    $ 1,570

K22

Revenues increased $205 million in 2013, but decreased $132 million in 2012. As reflected in the table below, the increase in 2013 resulted from higher volumes, partially offset by lower average revenue per unit as lower market-based export coal rates, the effects of changes in the mix of business, and slightly lower fuel surcharges more than offset rate increases. The decrease in 2012 was due to lower average revenue per unit (as the negative effects of changes in the mix of business offset rate increases and slightly higher fuel surcharges) and slightly lower volume. Fuel surcharge revenue totaled $1,254 million in 2013, $1,278 million in 2012, and $1,255 million in 2011. If fuel prices remain at or near year-end 2013 levels, fuel surcharge revenue will be relatively flat in 2014.

Revenue Variance Analysis

                           Increase (Decrease)

                   2013 vs. 2012          2012 vs. 2011
                             ($ in millions)

Volume (units)      $        363             $      (12)
Revenue per unit            (158)                  (120)

  Total             $        205             $     (132)

Many of our negotiated fuel surcharges for coal and industrial products shipments 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 applying WTI Average Price decreased fuel surcharge revenue by approximately $29 million in 2013, increased fuel surcharge revenue by approximately $39 million in 2012, and decreased fuel surcharge revenue by approximately $44 million in 2011.

Two of our customers, DuPont and Sunbelt Chlor Alkai Partnership ("Sunbelt"), have rate reasonableness complaints pending before the Surface Transportation Board (STB) alleging that our tariff rates for transportation of regulated movements are unreasonable. We dispute these allegations. Since June 1, 2009, in the case of DuPont, and April 1, 2011, in the case of Sunbelt, we have been billing and collecting amounts based on the challenged tariff rates. We presently expect resolution of these cases to occur in 2014 and believe the estimate of reasonably possible loss will not have a material effect on our financial position, results of operations, or liquidity. With regard to rate cases, we record adjustments to revenues in the periods, if and when, such adjustments are probable and estimable.

COAL revenues decreased $336 million, or 12%, compared with 2012, reflecting a 5% decrease in carload volume (tonnage hauled declined 4%) primarily due to fewer shipments of utility and domestic metallurgical coal. Average revenue per unit was down 7%, the result of lower pricing (mainly market-based export coal) and decreased fuel surcharge revenue, partially offset by the positive effect of changes in mix.

In 2012, coal revenues decreased $579 million, or 17%, compared with 2011, reflecting a 13% decrease in carload volume (tonnage was 12% lower) primarily due to fewer shipments of utility coal. Coal average revenue per unit was down 5% compared with 2011, the result of lower pricing (mainly market-based export metallurgical coal) and decreased fuel surcharge revenue, partially offset by the positive effect of changes in mix.

For 2014, coal revenues are expected to decrease, although more modestly, due to fewer carloads and lower average revenue per unit.

K23

Coal represented 23% of our revenues in 2013, and 79% of shipments handled originated on our lines. As shown in the following table, tonnage decreased in our utility and domestic metallurgical markets but increased slightly in our export and industrial markets.

                           Coal Tonnage by Market

                         2013       2012       2011
                            (tons in thousands)

Utility                 97,146    101,636    122,004
Export                  28,631     28,304     28,461
Domestic metallurgical  16,905     18,793     19,702
Industrial               7,388      7,376      7,713

  Total                150,070    156,109    177,880

Utility coal tonnage was down 4% in 2013 as compared to 2012. Utility coal shipments in our southern region decreased due to lower demand as utility stockpiles remained high and natural gas prices remained low. This decrease was partially offset by increased shipments in our northern region as higher coal burn necessitated stockpile replenishments to maintain targeted levels.

In 2012, utility coal tonnage dropped 17%, compared with 2011, reflecting competition from low natural gas prices and reduced electrical demand in NS-served regions. Additional tonnage declines resulted from plant closures and maintenance.

For 2014, we expect utility coal tonnage to decrease driven by continued weak demand as well as the loss of a contract.

Export coal tonnage increased 1% in 2013, compared with 2012. Despite strong global competition, we handled higher export thermal and metallurgical coal shipments as an increase in steel production in developing markets offset weakness in the European market. Volume through Norfolk was up 2.1 million tons, or 11%, whereas Baltimore volume decreased 1.4 million tons, or 17%. Other export volume decreased 0.4 million tons, or 36%.

In 2012, export coal tonnage decreased 1% compared with 2011, a reflection of weaker global demand for metallurgical coal used in steel production in NS-served markets, in addition to the negative impact of the return of Australian supply, offset in part by increased thermal shipments. Volume through Norfolk was down 1.3 million tons, or 6%, whereas volume through Baltimore increased 0.3 million tons, or 4%. Other export coal volume increased 0.8 million tons.

For 2014, export coal tonnage is expected to decrease as a result of strong competition in the Western European metallurgical coal market, in addition to soft demand and an oversupply of thermal coal.

K24

Domestic metallurgical coal tonnage was down 10% in 2013, compared with 2012, due to weaker domestic steel production, sourcing shifts away from coal origins we serve, and the permanent closure of a steel plant in mid-2012 that impacted the year-over-year comparison for the first half of 2013.

In 2012, domestic metallurgical coal tonnage was down 5% compared with 2011, as declines in coke and iron ore shipments (primarily due to the plant closure) offset improved domestic steel production experienced in the first half of 2012.

For 2014, domestic metallurgical coal tonnage is expected to be flat with 2013, as improved steel demand should offset losses due to sourcing shifts.

Industrial coal tonnage increased slightly in 2013, compared with 2012, as increased shipments to existing customers was partially offset by weaker industrial demand in the print paper and cement sectors.

In 2012, industrial coal tonnage decreased 4% compared to 2011, as weak industrial demand was partially offset by new business.

For 2014, industrial coal tonnage is expected to increase slightly due to higher demand in the U.S. industrial sector.

GENERAL MERCHANDISE revenues in 2013 increased $398 million, or 7%, compared with 2012, reflecting 4% growth in carload volume and a 3% improvement in average revenue per unit that reflected favorable changes in the mix of traffic (increases in higher-than-average revenue per unit traffic) as well as higher rates and fuel surcharges.

In 2012, general merchandise revenues increased $336 million, or 6%, compared with 2011, reflecting a 4% rise in average revenue per unit as a result of higher rates and fuel surcharges. Carload volume increased 2%.

Chemicals revenues in 2013 increased 14%, compared with 2012, reflecting 16% growth in volume partially offset by a 2% decline in average revenue per unit that resulted from the negative effect of the changes in mix due to increased crude oil shipments. The volume improvement was primarily the result of more carloads of crude oil from the Bakken and Canadian oil fields. Additionally, there were more carloads of liquefied petroleum gas in the Utica Shale region.

In 2012, chemicals revenues grew 7%, compared with 2011, reflecting 4% growth in volume and a 3% increase in average revenue per unit that resulted from higher rates and fuel surcharges. The volume improvement was largely the result of more carloads of crude oil from the Bakken and Canadian oil fields. Additionally, there were more carloads of liquefied petroleum gas, as well as higher shipments of plastics driven by greater demand for plastic bottles. These increases were offset in part by fewer shipments of rock salt as a mild winter resulted in higher inventory levels throughout 2012.

For 2014, chemicals revenues are anticipated to increase, largely a result of more shipments of crude oil and asphalt.

Agriculture, consumer products, and government revenues increased 1% in 2013, compared with 2012, as a 2% improvement in average revenue per unit (reflecting pricing improvements that were slightly offset by a negative change in mix related to the increase of lower-rated shorter-haul movements of corn) was partially offset by a slight decline in volume. The volume decline was driven by reduced shipments of soybeans and related products caused by tightened supplies of domestic beans and a strong South American crop, in addition to fewer revenue movements of empty equipment. Carload volume declines were partially offset by higher shipments of food oils as we handled new business with existing customers and more biodiesel carloads in advance of the anticipated elimination of the biodiesel tax credit. We also hauled more shipments of fertilizer due to a strong farm economy and increased planting activity.

K25

In 2012, agriculture, consumer products, and government revenues were relatively flat, compared with 2011, as higher average revenue per unit was offset by lower volume. The volume decline was driven by reduced corn shipments (due to plant closures), fewer carloads of fertilizer (led by certain network classification changes), and reduced shipments of wheat to the eastern U.S. (due to customer sourcing changes). These volume declines were offset in part by more shipments of soybean and soybean meal due to a poor South American bean crop, as well as higher shipments of corn-based feed to Texas.

For 2014, agriculture, consumer products, and government revenues are expected to improve as a result of higher average revenue per unit offset in part by a slight decrease in volume. The projected decline in volume is based primarily on fewer shipments of corn, as we anticipate that strong local production will prompt customer sourcing changes, as well as reduced shipments of wheat feed, with a partial offset by anticipated market share growth in perishables, beverages, and consumer products.

Metals and construction revenues increased 5% in 2013, compared with 2012. The revenue improvement resulted from 6% higher average revenue per unit, which reflected the positive change in mix of business as we transported higher-rated shipments of slag and fractionating sand for natural gas drilling, higher rates, and increased fuel surcharges. Although we moved more slag and fractionating carloads, volume declined modestly as we handled reduced shipments of iron and steel (driven by fewer import slabs and a steel plant closure during the third quarter of 2012) and scrap metal (a result of weakening demand).

In 2012, metals and construction revenues increased 8%, compared with 2011. The improvement resulted from 7% higher average revenue per unit, which reflected higher rates and fuel surcharges. Volume improved 1%, the result of more coil steel shipments driven by increased automotive production. The mild winter weather experienced in early and late 2012 led to more shipments of cement for construction projects. There were also higher shipments of fractionating sand for natural gas drilling. These increases were partially offset by fewer aggregates carloads, primarily driven by weak market conditions in road/highway construction, and as lower coal utility burn led to fewer shipments of scrubber stone.

For 2014, metals and construction revenues are expected to increase reflecting higher shipments of fractionating sand and other materials used for natural gas drilling, as well as additional shipments of steel used by the automotive and energy sectors. Average revenue per unit is also anticipated to improve.

Automotive revenues rose 10% compared to 2012, reflecting 7% growth in volume due to increased vehicle production at plants we serve and new business from existing customers (including both auto parts and finished vehicles). Average revenue per unit improved 2%, reflecting improved pricing and higher fuel surcharges.

In 2012, automotive revenues rose 15%, compared to 2011, reflecting a 13% rise in volume due to increased vehicle production at plants we serve and a 2% improvement in average revenue per unit, including fuel surcharges.

For 2014, automotive revenues are expected to grow as a result of volume gains driven by a continued increase in domestic production at plants we serve, in addition to higher average revenue per unit.

Paper, clay and forest products revenues increased 3% in 2013, compared with 2012, reflecting 1% gains in both volume and average revenue per unit. Volume increases for lumber, pulp, and pulpboard were offset by reduced demand for newsprint and paper.

In 2012, paper, clay, and forest products revenues increased 3%, compared with 2011, reflecting a 5% improvement in average revenue per unit due to increased rates, which more than offset the effects of a 3% volume decline. The lower volume was due to reduced shipments of miscellaneous wood driven by the loss of business and fewer carloads of pulp as a result of declining export market demand.

K26

For 2014, paper, clay, and forest products revenues are anticipated to decline as we expect reduced shipments of miscellaneous wood (due to market share loss), in addition to fewer shipments of pulp and graphic paper as demand declines, partially offset by improvements in the housing market and higher average revenue per unit.

INTERMODAL revenues increased $143 million, or 6%, compared with 2012, reflecting a 6% growth in volume. Average revenue per unit was flat.

Domestic volume (including truckload and intermodal marketing companies, Triple Crown Services, and Premium business) improved 7%, the result of continued highway-to-rail conversions and additional business associated with the opening of new intermodal terminals. International traffic volume grew 6%, due to growth with existing customers as the economy continued to improve.

In 2012, intermodal revenues increased $111 million, or 5%, compared with 2011, reflecting 5% growth in volume largely due to increased domestic units resulting from continued highway-to-rail conversions. Average revenue per unit improved 1% as a result of higher fuel surcharges, partially offset by lower pricing. Domestic volume increased 8%, reflecting continued highway conversions. International volume declined 1%, as the loss of business from a shipping line was partially offset by growth across remaining international customers.

For 2014, intermodal revenues are expected to increase due to higher volume and average revenue per unit as a result of continued highway conversions and growth associated with our new intermodal terminals.

Railway Operating Expenses

Railway operating expenses in 2013 were $8.0 billion, up $72 million, or 1% compared to 2012. Expenses in 2012 were $7.9 billion, down $43 million, or 1%, compared to 2011. In 2013, higher wage rates and volume-related expense increases were offset in part by lower costs resulting from network efficiencies. For 2012, the decrease reflected the absence of 2011's $58 million unfavorable arbitration ruling and lower costs due to gains in network efficiency, offset in part by higher volume-related expenses.

The following table shows the changes in railway operating expenses summarized by major classifications.

                                 Operating Expense Variances
                                     Increase (Decrease)

                             2013 vs. 2012        2012 vs. 2011
                                      ($ in millions)

Compensation and benefits       $       42           $      (14)
Fuel                                    36                  (12)
Purchased services and rents            25                   (6)
Depreciation                             -                   54
Materials and other                    (31)                 (65)

  Total                         $       72           $      (43)

K27

Compensation and benefits, which represents 38% of total operating expenses, increased $42 million, or 1%, in 2013, reflecting changes in:

pay rates (up $59 million),

incentive and stock-based compensation (up $39 million),

lower activity levels (down $48 million) that reflected improved employee productivity, and

payroll taxes (down $16 million).

In 2012, compensation and benefits decreased $14 million compared with 2011, primarily due to changes in:

employee activity levels (down $40 million),

incentive and stock-based compensation (down $35 million),

pay rates (up $43 million), and

pension and postretirement benefit costs (up $16 million).

Our employment averaged 30,103 in 2013, compared with 30,943 in 2012, and 30,329 in 2011. The decrease in 2013 reflected the benefit from operational efficiencies. Looking forward to 2014, we expect employment levels to be consistent with those of 2013. In addition, as a result of net actuarial gains related to pension and other postretirement benefits, we expect expenses associated with these benefits to be approximately $25 million lower per quarter in 2014. We also expect favorable labor hour trends to continue. These declines are expected to be offset in part by higher wage rates.

Fuel expense, which includes the cost of locomotive fuel as well as other fuel used in railway operations, increased $36 million, or 2%, in 2013, but decreased $12 million, or 1%, in 2012. The increase in 2013 was principally the result of higher locomotive fuel consumption (up 4%), offset in part by lower locomotive fuel prices (down 2%).

The decrease in 2012 reflected lower locomotive fuel consumption (down 3%), offset in part by higher locomotive fuel prices (up 3%).

Purchased services and rents includes the costs of services purchased from outside contractors, including the net costs of operating joint (or leased) facilities with other railroads and the net cost of equipment rentals. This category of expenses increased $25 million, or 2%, in 2013, but decreased $6 million in 2012.

                     2013        2012        2011
                            ($ in millions)

Purchased services $  1,353    $  1,321    $  1,272
Equipment rents         276         283         338

Total              $  1,629    $  1,604    $  1,610

The increase in 2013 for purchased services costs reflected higher volume-related activities and software expenses, partially offset by lower professional and consulting fees and travel expenses. The increase in 2012 reflected higher professional and consulting fees, intermodal operations expenses, Conrail-related casualty costs ($15 million), and advertising expenses. These increases were partially offset by lower haulage expenses.

Equipment rents, which includes our cost of using equipment (mostly freight cars) owned by other railroads or private owners less the rent paid to us for the use of our equipment, decreased in 2013 and 2012 as a result of increased velocity and improved equipment utilization.

K28

Depreciation expense was flat in 2013, but increased $54 million, or 6%, in 2012. Both periods reflected our larger roadway and equipment capital base as we continue to invest in our infrastructure and rolling stock. In 2013, that increase was completely offset by the favorable impact of an equipment study that was completed during the first quarter of 2013. We expect depreciation expense in 2014 to be approximately $40 million higher than 2013.

Materials and other expenses decreased $31 million, or 4%, in 2013, and $65 million, or 7%, in 2012, as shown in the following table.

                             2013      2012      2011
                                  ($ in millions)

Materials                   $  422    $  408    $  408
Casualties and other claims     90       130       216
Other                          316       321       300

  Total                     $  828    $  859    $  924

In 2013, lower expenses for casualties and other claims more than offset higher costs for materials. Casualties and other claims expenses include the estimates of costs related to personal injury (PI), property damage, and environmental matters. Over the last two years, we have experienced lower PI expenses that have been offset in part by higher environmental expenses, resulting in net benefits of $52 million in 2013 and $27 million in 2012. The lower PI expenses have been driven by improved historical trend rates, resulting in favorable reserve adjustments for prior years' claim amounts. Going forward, if favorable trends continue for PI costs, we could see additional favorable adjustments, however, likely not at the levels experienced in 2013.

The decrease in 2012 reflected the absence of 2011's unfavorable arbitration ruling discussed below and the favorable reserve developments discussed above. These favorable items were partially offset by higher costs associated with property taxes.

The Consolidated Balance Sheets reflect long-term receivables for estimated recoveries from our insurance carriers for claims associated with the January 6, 2005, derailment in Graniteville, S.C. In the first quarter of 2011, we received an unfavorable ruling for an arbitration claim with an insurance carrier and were denied recovery of the contested portion of the claim. As a result, we recorded a $43 million charge for the receivables associated with the contested portion of the claim and a $15 million charge for other receivables affected by the ruling for which recovery was no longer probable.

PI cases involving occupational injuries comprised about 28% of total employee injury cases resolved and about 17% of total employee injury payments made. With our long-established commitment to safety, we continue to work actively to eliminate all employee injuries and reduce the associated costs. With respect to occupational injuries, which are not caused by a specific accident or event but . . .

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