Remarks by:
James A. Squires
Executive Vice President Finance and Chief Financial Officer
Norfolk Southern Corporation
Thank you Don. I’ll now provide a review of our overall financial results for the third quarter.
Net Income and Diluted Earnings per Share
Net income for the quarter was $386 million, a decrease of $30 million, or 7 percent, compared with the $416 million earned in the third quarter last year.
Diluted earnings per share for the quarter were 97 cents, which was five cents per share, or 5 percent, less than last year. The decreases in both net income and earnings per share reflect the impact of Illinois tax legislation enacted during the third quarter which was $19 million, or 5 cents per diluted share, shown in yellow. Excluding that item, diluted earnings per share would have been $1.02, even with last year.
Let’s start with an overview of our operating results.
Income From Railway OperationsThird Quarter 2007 vs. 2006
As Don described, railway operating revenues declined $40 million, or 2 percent. This resulted in a $34 million, or 5 percent decrease in income from railway operations as operating expenses declined by $6 million.
The railway operating ratio rose 1 percentage point from the record low of 70.1 in the third quarter of 2006.
Railway Operating Expenses Short-Term Cost Control
Before reviewing the operating expenses, let me comment on short-term cost controls. While our cost structure does have a large fixed component, there are, of course, costs we can vary in the short term. We divide these into two categories: those linked to current business levels and those that affect our ability to capture future opportunities.
Norfolk Southern’s long-term prospects dictate our approach to costs associated with future opportunities. In spite of the current volume softness, we believe demand for rail transportation will grow. Therefore, as shown on the right side of the slide, we have continued to spend prudently on maintenance. A well-maintained network, in addition to enhancing service, allows us to attract and retain future business. Moreover, a stable pattern of spending minimizes outlays in the long run. At the same time, current volume conditions have allowed us to cut spending in the areas shown on the left side.
Now let’s look at the expenses in detail.
Railway Operating Expense Analysis
The largest reduction was in casualties and other claims, which declined $17 million. This decrease is largely due to favorable personal injury and lading claims development, demonstrating the impact of our employees’ continued commitment to safety. In addition, the quarter benefited from an environmental insurance settlement.
Compensation and benefits decreased $5 million, or 1 percent, in the third quarter compared with last year. This is a modest change, but there are a few moving parts I would like to point out.
Compensation and Benefits Analysis
First, stock-based compensation rose $15 million in the quarter due entirely to last year’s $9.17 per share quarterly stock price decline. Next, the accrual for incentive compensation decreased $10 million reflecting the higher bar set for our bonus calculation. And finally, there was a $10 million decrease from lower volume-related payroll costs. This is one example of variable costs that we try to carefully manage by watching our payroll hours in the areas directly affected by traffic volume (such as train crews) while not pulling back on hours in our maintenance areas. This is not to say the plans can’t be modified. They can, but always with a longer-term view.
Railway Operating Expense Analysis
Turning to the expense increases, diesel fuel expense rose by $1 million.
Diesel Fuel Cost Analysis
Here again, you can see our focus on the part of the cost equation that is controllable. Fuel consumption was down $13 million, reflecting a 5 percent drop in gallons used that exceeded the 4 percent traffic volume decline. This largely mitigated higher fuel prices which rose $14 million in the quarter.
Railway Operating Expense Analysis Third Quarter 2007 vs. 2006
Materials, services and rents increased $3 million, or 1 percent, in the third quarter compared with last year, as lower volume-related equipment rents partially offset higher maintenance costs. A strong focus on asset utilization enabled an 8 percent decline in equipment rents.
Railway Operating Expense Analysis
Other operating expenses increased by $4 million, or 7 percent, primarily due to higher property, sales and use and franchise taxes.
And finally, depreciation expense increased by $8 million, or 4 percent, reflecting continuing investment in our network and equipment.
Non-operating Items Third Quarter 2007 vs. 2006
Now let’s turn to our non-operating items.
Other income - net for the quarter was $31 million compared with $41 million last year, a decline of $10 million.
Gains on sales of property and investments rose $14 million this quarter. As you know, the timing of these sales is somewhat unpredictable, but year-to-date we are about even with 2006.
Interest income decreased $11 million as a result of lower cash balances and returns from corporate owned life insurance declined $8 million.
Interest expense on debt was $13 million lower than last year, largely due to less outstanding debt.
Now I’d like to provide some detail concerning our synthetic fuel investments.
Synthetic Fuel Investments Third Quarter 2007 vs. 2006
This slide shows amounts recognized during the third quarter related to our synthetic fuel investments which, as you know, have a pre-tax and an after-tax component. As of the end of the third quarter, the tax credit phase-out was expected to be 43 percent. The net benefit from these investments in the third quarter was $7 million. This was $11 million less than we projected three months ago due entirely to the rise in oil prices during the quarter.
Expected Synthetic Fuel Effects Fourth Quarter 2007
Assuming the same 43 percent phase-out that was projected as of quarter end, our synthetic fuel investments would result in a total net benefit of $16 million for the remainder of 2007 compared with $7 million in the fourth quarter of 2006. That 43 percent phase-out equated to a NYMEX per barrel average price for the last three months of the year of about $81.
Of course, as you know, oil prices have risen significantly since quarter end. Each dollar variability in that average price affects the net benefit by almost $2 million. For example, should the average price for the fourth quarter approach $90 per barrel, our net benefit for the quarter would be zero.
Income Before Income Taxes Third Quarter
Turning back to our results, third quarter income before income taxes declined 5 percent, reflective of the lower traffic volumes.
Income Taxes Third Quarter
Income taxes for the third quarter were $219 million compared with $220 million last year. The effective tax rate of 36.2 percent compared with a rate of 34.6 percent in 2006. The increase resulted from expenses associated with recently enacted Illinois tax legislation, which increased deferred taxes by $19 million.
For the full year, assuming a 43 percent synthetic fuel tax credit phase-out, the effective tax rate will be around 34 percent. I want to reiterate that this is affected by changes in oil prices. For example, if the average oil price for the fourth quarter is $90 a barrel, our full year effective tax rate will be 35 percent.
And now I will update you on our Share Repurchase Program.
Share Repurchase Program Quarterly Activity
This slide shows quarterly purchases since inception. During the third quarter of 2007, we bought back 6.7 million shares of stock at a cost of $341 million. In total, we have purchased and retired 36.9 million shares for $1.7 billion, at an average price of $46.93 per share. This represents about half of our existing share repurchase authorization.
Thank you for your attention and I will now turn the program back to Wick. |
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