Remarks by:
Henry C. Wolf
Vice Chairman and Chief Financial Officer
Norfolk Southern Corporation
Good morning.� Our second quarter and year-to-date financial results set new records for railway operating revenues and income from railway operations.� In addition, our results for the first six months established a new record for net income and earnings per share.
Significant Prior Year Items
As you may recall in the second quarter of 2005, we recognized income from a change in the Ohio tax laws that added $96�million, or 23 cents per share to our reported earnings.� In addition, we reached settlements with two utility companies which resolved their cases before the Surface Transportation Board.� These settlements added $24�million of net income, or 6 cents per share.� As I conclude my remarks this morning, I would like to provide you with comparisons that exclude these two items.
Now, let’s turn to our second quarter and first half year results.
Railway Operating Revenues - Second Quarter and Six Months
Railway operating revenues for the second quarter were a record $2.4�billion, up $238�million, or 11 percent, compared with last year.�
For the first six months, railway operating revenues were a record $4.7�billion, an increase of $580�million, or 14�percent.
Railway Operating Revenue Variance Analysis
Second quarter volume rose by 77,000 units, or 4�percent, compared with last year, driven by a 59,000, or 8 percent, increase in intermodal units.� In addition, the average revenue per unit increased by 7 percent, reflecting increased fuel surcharges and higher rates, which coupled with the 4 percent increase in volume produces an 11 percent increase in operating revenues.�
I should note that the 11 percent improvement in operating revenues represents a more difficult comparison, since last year’s second quarter operating revenues included the rate case settlements.� Excluding that addition to 2005 operating revenues the quarter over quarter increase in revenues would be 14�percent.
For the first six months, volumes rose by 171,000�units, or 4�percent while revenue per unit increased by 10 percent to yield a 14�percent increase in railway operating revenues.
Don Seale will provide you with the details of our revenues in a moment.
Railway Operating Expenses – Second Quarter and Six Months
Railway operating expenses for the second quarter were $1.7�billion, up $153�million, or 10�percent, compared with 2005.
For the first six months, railway operating expenses were $3.5�billion, $347�million, or 11�percent, higher than 2005.
Railway Operating Expense Analysis - Second Quarter
The largest increase in operating expenses for the quarter was in diesel fuel, up $98�million, or 60�percent.�
Diesel Fuel Cost Analysis - Second Quarter
Second quarter fuel costs surged to $260 million compared with $162 million last year.� The primary driver of that increase was higher prices per gallon of diesel fuel which added $60�million.� Our benefit from fuel hedging was $35 million less in the second quarter than last year, and consumption was up $3�million, or 2 percent, on the 4 percent increase in traffic volume.
As you will recall, our hedging program wound down in May of this year, and the absence of hedge benefits make for even tougher comparisons this year.
Railway Operating Expense Analysis - Second Quarter
The next largest increase was in casualties and other claims expense, which rose $25�million, or 63 percent, compared with last year.�
In the last two quarters, we have experienced volatility in our casualties and other claims expenses because of a greater number of derailments involving high value lading such as automobiles, and also because of higher insurance costs.�
More than half of this quarter’s increase is attributed to lading and equipment costs associated with derailments.� The remaining variance is principally due to higher personal injury costs and increased premiums for casualty and property insurance.
Railway Operating Expense Analysis - Second Quarter
Materials, services and rents rose by $25�million, or 6 percent, in the second quarter.
Materials, Services and Rents Expense Analysis – Second Quarter
Within this category, purchased services increased by $16�million, primarily for intermodal services, reflecting the 8 percent increase in intermodal traffic volume.� Materials expense rose $8 million, largely a result of maintenance activities, and equipment rents increased $1 million.��
Railway Operating Expense Analysis - Second Quarter
Compensation and benefits expenses for the second quarter rose $13 million, or 2�percent, compared with last year.
Compensation and Benefits Expense Analysis – Second Quarter
�This increase is attributable to: 1) higher medical insurance costs for both active and retired employees which rose by $7 million; 2)�higher wage rates that added $6 million; 3)�increased hours for train and engine employees that added $4 million; and 4)�payroll taxes that added another $4 million.� These increases were offset in part by $6�million less in life insurance costs and $2�million less in other miscellaneous items.
Railway Operating Expense Analysis - Second Quarter
Depreciation expense was down $12�million, or 6 percent.� As you will recall, this is due to a required periodic depreciation study completed in the first quarter of this year, which indicated longer depreciable lives for some of our assets.
Railway Operating Expense Analysis – Six Months
For the first six months, railway operating expenses were up $347�million, or 11�percent.� As in the case of the second quarter, the largest increase for the first half was in diesel fuel expense.
Railway Operating Expense Analysis – Six Months
The $179�million increase in diesel fuel was largely due to higher prices which accounted for $111�million of this increase.� The benefit from fuel hedging was $60 million less than last year, and increased consumption added $8�million.
Railway Operating Expense Analysis – Six Months
The second largest increase was in compensation and benefits expense which increased by $130�million, or 11�percent.
Compensation and Benefits Variance Analysis – Six Months
As you will recall, we implemented SFAS 123(R) on January 1, 2006, and our expenses include $33 million related to this change in accounting.� In addition, the increase in compensation and benefits includes:
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$30 million of other stock-based compensation, primarily stemming from the increase in Norfolk Southern’s stock price,
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$16 million for increased medical insurance benefits,���������
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�$13 million related to retirement agreements and waiver agreements with two former executives in the first quarter,
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$13 million of higher payroll taxes,
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$12 million of increased wage rates,�
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$11 million for the cost of the regular annual stock-based grant to the former Chief Executive Officer who retired in the first quarter,
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$10 million reflecting the cost of additional hours for train-service employees, and
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Other miscellaneous items reduced these compensation and benefits cost increases by $8�million.
Railway Operating Expense Analysis – Six Months
For the first six months materials, services and rents expense were $60 million, or 7�percent, higher than the same period last year.
Materials, Services and Rents Expense Analysis – Six Months
For the first half of the year, purchased services rose $30�million and materials expense increased $21 million, both reflecting higher traffic volume and increased maintenance activities.� Equipment rents were up $9 million, primarily due to increased volume.
Railway Operating Expense Analysis – Six Months
For the first six months, Casualties and other claims expense were even with 2005, as current year derailment costs almost equaled the costs related to the Graniteville accident last year.
Railway Operating Expense Analysis – Six Months
Depreciation expense for the first half decreased $22 million, or 6 percent, a result of the depreciation study that we received in the first quarter.
Railway Operating Ratio – Second Quarter and Six Months
The railway operating ratio for the second quarter was 71.7 percent, compared with a ratio of 72.5 percent in the second quarter of 2005.� This represents the best quarterly operating ratio since the integration of Conrail in 1999.
For the first six months, the operating ratio was 73.8 percent compared with 75.8�percent for the same period last year.
Income From Railway Operations – Second Quarter and Six Months
Second quarter income from railway operations was a record $677�million, up $85�million, or 14�percent, over the $592�million produced last year.�
For the first six months, income from railway operations was also a record at $1.2�billion, up $233�million, or 23�percent.
Total Other Income (Expense) - Second Quarter
Total other income and expense for the second quarter was an expense of $88�million, compared with an expense of $117 million in 2005.�
�Expenses related to our synfuel investments were $18 million lower this year, reflecting the expected phase-out of a portion of certain Section 29 tax credits due to high oil prices.� Interest income rose $13 million over last year, a result of higher invested cash balances and higher interest rates.
Interest expense on debt was $5�million lower than last year reflecting less debt outstanding.
Total Other Income (Expense) – Six Months
For the first six months, total other income and expense was an expense of $173�million compared with an expense of $243�million in 2005.�
Expenses related to our synfuel investments were $25�million lower than last year, again, reflecting the expected phase-out of a portion of those Section 29 tax credits due to high oil prices.�
Interest income increased $23 million and gains on sales of property and investments were $12�million higher.
Interest expense on debt for the first six months was $13 million lower than last year, again largely due to less outstanding debt.
Income Before Income Taxes
Second quarter income before income taxes was $589�million, compared with $475�million last year, a 24�percent increase.� For the first six months, income before income taxes was $1.1�billion, up 40�percent compared with $752�million in 2005.
Provision For Income Taxes
The provision for income taxes for the second quarter was $214 million compared with $51 million last year.� As I mentioned earlier, last year was positively impacted by the $96 million non-cash tax benefit associated with the changes in Ohio tax laws.� The effective tax rate for this quarter was 36.3�percent, compared with 10.7�percent last year.� The Ohio tax law change reduced last year’s second quarter effective tax rate by 20.2 percentage points.� The remaining 5.4�percentage point increase in the effective tax rate this quarter is largely the result of significantly reduced tax credits projected on our Section 29 tax credit investments.�
As you may recall, we made investments in synthetic fuel operations that produce tax credits under Section 29 of the Internal Revenue Code.� These tax credits are reduced, or phased-out, as oil prices reach certain levels specified in the law.� In the first quarter, we experienced some reductions in the amount of tax credits available due to high oil prices.� With even higher prices in the second quarter, we are experiencing even greater reductions which have the effect of increasing our effective tax rate.� Because of the tax credit phase-out, our second quarter reflects $34�million less in tax benefit from these credits, when compared with the second quarter of 2005.�
For the first half, the provision for income taxes was $375 million, compared with $134�million last year, and the effective rate was 35.5 percent, compared with 17.8 percent in 2005.� The Ohio tax law change reduced last year’s first half rate by 12.8 percentage points and again, the remaining 4.9�percent difference in the effective rate is attributable to the phase-out of the Section�29 tax credits due to the higher oil prices.�
I should also point out that a complete phase-out of these tax credits for the year would result in the reversal of $9 million of net benefits, comprised of $17 million of pre-tax investment expenses and $26 million of tax benefits, that have been recognized and accrued in the first six months of this year.
Net Income
Second quarter net income was $375�million compared to $424�million reported for the second quarter of 2005, which includes the $96 million benefit associated with the change in Ohio tax laws and the $24 million related to the settlement of the coal rate cases.
For the first six months, net income was a record $680�million compared with $618�million last year, an increase of $62�million, or 10�percent.
Diluted Earnings Per Share
Diluted earnings per share for the second quarter were 89 cents compared with $1.04�per share reported last year.
For the first six months, diluted earnings per share were $1.61, which was 7�percent above the $1.51 per share reported a year ago.
Net Income – Excluding Significant Items
Last year I provided you with a comparison of our net income and earnings per share excluding the effects of the change in Ohio tax laws and the settlements for the rate cases.� On that basis, this year’s second quarter net income of $375 million would have been $71�million, or 23�percent, higher than second-quarter 2005; and our net income for the first six months of $680 million would have been $182�million, or 37 percent, higher than the same period in 2005.
Diluted Earnings Per Share – Excluding Significant Items
Similarly, our second quarter diluted earnings per share of 89 cents would have been 19 percent higher than the 75 cents per share earned in second quarter 2005 excluding the Ohio tax law change and the coal rate cases settlements.� Our year-to-date earnings per share of $1.61 would have been 32 percent higher than the $1.22 earnings per share earned last year calculated on the same basis.
Reconciliation of Net Income
This slide reconciles the net income and earnings per share for the second quarter and first six months of 2005 excluding the Ohio tax legislation and the two rate cases to our reported net income and earnings per share. This reconciliation is posted on our web site for your reference.
Thank you for your attention and now I’ll turn the program over to Don Seale, who will give you an in?depth report on our revenues.
Remarks by Donald W. Seale >> |
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