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 fourth quarter as well as a free cash flow and capital structure review.
Net Income and Diluted Earnings per Share – Fourth Quarter
Net income for the quarter was $399 million, an increase of $14 million, or 4 percent, compared with $385 million.
Diluted earnings per share for the quarter were $1.02, which was 7 cents, or 7 percent, more than last year.
Income From Railway Operations – Fourth Quarter 2007 vs. 2006
Looking at our operating results, both revenues and profits from railway operations set fourth quarter records. The 6 percent increase in revenues Don described combined with only a 4 percent rise in expenses resulted in a $72 million, or 12 percent, increase in income from railway operations.
The railway operating ratio improved 1.5 percentage points to 72.0 in the fourth quarter of 2007.
Before we review our operating expenses in detail, I would like to update you on some reclassifications in our income statement line items.
Railway Operating Expenses – Income Statement Line Items
The new income statement line items, including reclassifications, are shown here. The most notable reclassification relates to fuel. As you are aware, beginning with the fourth quarter 2007, the STB will require railroads to provide certain information regarding fuel, such as surcharge revenue, fuel expense and gallons consumed. Previously, our income statement line item entitled “Diesel Fuel” included only those expenses related to the diesel fuel consumed by locomotives. In connection with the reporting requirements to the STB, we will now include all costs related to all fuel used in railroad operations in our line item “Fuel.” This includes items such as fuel used by our vehicle fleet and our roadway machines.
In addition, we have made a couple of other reclassifications to provide for smaller groupings on the income statement. Please note that all of the components are still available in the detail in the back of the quarterly analyst book.
Railway Operating Expense Analysis – Fourth Quarter 2007 vs. 2006
Turning to our expense detail, the largest increase was fuel, which rose $97 million, or 38 percent.
Fuel Cost Analysis – Fourth Quarter 2007 vs. 2006
Higher prices resulted in an additional $103 million of costs. Our average cost per gallon was $2.56, a 43 percent increase compared with 2006. Locomotive fuel consumption declined $6 million, or 3 percent, commensurate with the 3 percent decrease in traffic volume.
Railway Operating Expense Analysis – Fourth Quarter 2007 vs. 2006
Depreciation expense rose by $10 million, or 5 percent, reflecting continuing investment in our network and equipment.
Compensation and benefits decreased $32 million, or 5 percent, in the fourth quarter compared with last year.
Compensation and Benefits Analysis – Fourth Quarter 2007 vs. 2006
Stock-based compensation declined $15 million in the quarter due almost entirely to the combination of last year’s $6.24 per share quarterly stock price increase and this year’s $1.47 per share decrease. Next, the accrual for incentive compensation was $13 million lower reflecting the higher bar set for our bonus calculation. And finally, other items combined to contribute $4 million to the decline, as lower volume-related payroll more than offset the effects of higher wages and benefit costs.
Railway Operating Expense Analysis – Fourth Quarter 2007 vs. 2006
Materials and other decreased $7 million, or 3 percent, reflecting lower derailment and personal injury expenses, which are included in this line item along with other components of what was previously “Casualties and other claims.”
Purchased services and rents declined $5 million, or 1 percent, primarily due to lower volume-related equipment rents.
Non-operating Items – Fourth Quarter 2007 vs. 2006
Now let’s turn to our non-operating items.
Other income - net for the quarter was $34 million compared with $40 million last year, a decline of $6 million.
Equity in Conrail earnings increased $20 million from last year primarily due to favorable adjustments related to the settlement of a federal tax audit.
Returns from corporate owned life insurance decreased $14 million and interest income decreased $8 million as a result of lower cash balances.
Interest expense on debt was $7 million lower than last year, largely due to less outstanding debt.
Now, for the last time, I’d like to provide some detail concerning our synthetic fuel investments.
Synthetic Fuel Investments – Fourth Quarter 2007 vs. 2006
This slide shows amounts recognized during the fourth 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 year, the tax credit phase-out was expected to be 66 percent. Because of this high phase-out, the quarter reflects a $7 million loss on these investments compared with a $7 million benefit last year. As you are aware, this was the last year of Section 29 credits. For the full year, we had a net benefit of $13 million compared to an $18 million benefit in 2006.
Income Taxes – Fourth Quarter
Total taxes for the fourth quarter were $213 million compared with $154 million last year. The much higher effective tax rate of 35 percent, compared with a rate of 29 percent in 2006, was driven primarily by the phase-out of the synthetic fuel credits.
Net Income and Diluted Earnings per Share - Year
While fourth quarter net income was 4 percent above last year, full year results were $17 million, or 1 percent, below 2006.
Diluted earnings per share for 2007 were $3.68, which is 11 cents per share, or 3 percent, more than 2006.
Now I would like to update you on our free cash flow and capital structure.
Free Cash Flow – 2005-2007
For the third consecutive year, our cash provided by operating activities was over $2 billion. As you can see, capital expenditures have increased over this same period. In a few minutes, Deb Butler will update you with regard to our capital plans for 2008.
Free cash flow, which is after capital expenditures, was approximately $1 billion in each of the past three years, well above our historical free cash flow. These levels of profitability have enabled us to increase our dividend as well as make significant share purchases in the last two years.
Dividends Paid
The dividend has risen at a compound annual rate of 41% over the past two years from 48 cents per share to 96 cents per share. Yesterday, the Board voted to further raise the dividend by 12% to 29 cents per share per quarter, which is 32% above the 22 cents paid a year ago. These dividend increases are supported by the strong cash flow generation of our business and demonstrate management’s commitment to achieve a payout ratio of approximately one-third of net income. In 2007, Norfolk Southern paid 26% of its net income as dividends.
Recent market volatility in combination with consistent dividend increases has resulted in an indicated yield for NS of approximately 2.5%, a significant premium compared with 1.5% for the other US Class 1 railroads and about 2% for the S & P 500.
Share Repurchases
This slide shows our share repurchase activity for the past two years. During 2006, we purchased 21.7 million shares at a total cost of $1.0 billion. During the fourth quarter of 2007, we bought back 8.4 million shares of stock at a cost of $428 million. This brings our total purchases for 2007 to 23.6 million shares at a total cost of $1.2 billion.
Provided that the economy cooperates, we expect to continue to generate significant free cash flow. This, along with debt issuances, is expected to provide the resources necessary to continue along this path. As a result, subject to economic and market conditions, we expect to repurchase a similar amount of shares in 2008.
Thank you for your attention and now, for an operations update, I will turn the program over to the Railroader of the Year, Steve Tobias.
Remarks by Stephen C. Tobias >> |
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